Business Associations

I. AGENCY 4
A. Introduction 4

B. Authority 5
Morris Oil v Rainbow Oilfield 7
Matter of Allender Company 8

C. Duty of Loyalty 8
Tarnowski v. Resop 9
Kidd v. Thomas Edison 9
Watteau v. Fenwick 10

II. PARTNERSHIP 10
A. Partnership Formation 10
Martin v. Peyton 11
Lupien v. Malsbenden 11

B. Legal Nature of Partnership 12

C. Operation of Partnerships 12
National Biscuit v Stroud 12
Sanchez v Saylor 12
Summers v. Dooley 13

D. Authority of a Partner 14

E. Liability for Partnership Obligations 14

Davis v Loftus 15

F. Partnership Interests and Partnership Property 15

in re Gerlach's Estate 15
Balafas v Balafas 16
Rappaport v. 55 Perry 16

G. Duty of Loyalty 16
Meinhard v. Salmon 17

H. Dissolution By Rightful Election 17

Page v Page 17
Girard Bank v Haley 19
Dreifuerst v. Dreifuerst 19

I. Dissolution By Judicial Decree and Wrongful Dissolution 19

Drashner v. Sorenson 21

III. ALTERNATIVE FORMS OF BUSINESS ORGANIZATIONS 21

A. Limited Partnerships 21
Gateway Potato Sales v. G.B. Investment Co. 22
Gotham Partners v Hallwood Realty , Del. Sup Ct., 2002 22

B. Corporate General Partners 22

in re USA Cafes, LP 23
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C. Limited Liability Companies 24
PB Real Estate Inc v. DEM II Properties 25
Hollowell v. Orleans Regional Hospital 25
McConnell v. Hunt Sports Enterprises 25

D. Limited Liability Partnerships 26

IV. THE CORPORATE FORM 26

A. Characteristics of the Corporation 26

B. Selecting a State of Incorporation 27

C. Organizing a Corporation 27

D. Preincorporation Transactions by Promoters 28

E. Consequences of Defective Incorporation 28

Cantor v. Sunshine Greenery, Inc. 29
Harris v Looney 29

F. Classical Ultra Vires Doctrine 29

Goodman v. Ladd Estate Co. 29

G. The Objective and Conduct of the Corporation 30

A.P. Smith Mfg. Co. v. Barlow 30

H. The Nature for Corporate Law 31

V. CORPORATE STRUCTURE 31
A. Shareholdership in Publicly Held Corporations 31

B. Allocation of Legal Power Between Management and Shareholders 32

Charlestown Boot & Shoe Co. v. Dunsmore 34
Schnell v. Chris-Craft Industries, Inc. 34
Blasius Industries, Inc. v. Atlas Corp. 35
Stroud v Grace 35
Williams v Geier 35
Teamsters v Fleming Companies 35
General Datacomm Industries, Inc. v. Wisconsin Investment Board 36
Hilton Hotels Corp v ITT Corp 36
MM Companies v Liquid Audio 36

C. Legal Structure of Management 37

D. Formalities Required for Action by the Board 38

E. Authority of Corporate Officers 38

F. Formalities Required for Shareholder Action 39

G. Cumulative Voting 39

H. Limited Liability 39
Fletcher v. Atex, Inc. 41
Walkovszky v. Carlton 41
Minton v. Cavaney 41

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 Sea-Land Services, Inc. v. Pepper Source 41
Kinney Shoe v Polan 42

I. Equitable Subordination of Shareholder Claims 42

J. The Corporate Entity and the Interpretation of Statutes and Contracts 42

VI. SHAREHOLDER INFORMATIONAL RIGHTS AND PROXY VOTING 42

A. Shareholder Informational Rights Under State Law 42
Security First v US Die Casting and Development 43
Saito v McKesson HBOC, Inc. 43

B. Shareholder Informational Rights Under Federal Law and Stock Exchange Rules 44

C. Proxy Rules: Overview 44

D. Proxy Rules: Private Actions Under the Proxy Rules 45

Mills v Electric Auto-Lite 46
Virginia Bankshares, Inc. v. Sandberg 46

E. Proxy Rules: Shareholder Proposals 47

Roosevelt v. E.I. Du Pont de Nemours & Co. 47
Amalgamated Clothing and Textile v Wal-Mart Stores 47

F. Proxy Contests 48
Rosenfeld v. Fairchild Engine and Airplane Corp. 48

VII. THE DUTY OF CARE AND THE DUTY TO ACT LAWFULLY 48

A. Duty of Care 48
Joy v North 50
Parnes v Bally Entertainment 50
Freancis v. United Jersey Bank 50
Kamin v. American Express Co. 51
Smith v. Van Gorkom 51
In re Caremark International Inc. Derivative Litigation 52

B. Duty to Act Lawfully 52

Miller v. American Telephone & Telegraph 52

VIII. DUTY OF LOYALTY 53

A. Self-Interested Transactions 53
Lewis v. S.L. & E., Inc. 54
In re Walt Disney Derivative Litigation , Del., 2003 54
Talbot v. James 54

B. Statutory Approaches 55
Cookies Food Products v. Lake Warehouse 56
Emerald Partners v Berlin , Sup. Ct. Del., 2001 56

C. Compensation, the Waste Doctrine, and the Efect of Shareholder Ratification 57

Harbor Finance v Huizenga , Del Chancery, 1999 57

D. The Corporate Opportunity Doctrine 57

Hawaiian International Finance v Pablo , HW, Sup. Ct., 1971 58
Northeast Harbor Golf Club, Inc. v. Harris 59
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 Business Associations

Exam: Designed to require you to study everything

Expect a Curve Ball Question
Complex and Thick answers, two lines writing in ambiguity
Exam on file in library
many mini-essays covering everything in class
Essay will be a traditional fact pattern on one of the more contestable areas
Multiple Choice: Trying to teach how to read closely, pick the best answer as all may be correct
Exam question, will have many conflicting issues and facts. Many facts that you will need to put in your
legal "templates" and apply
No conclusion necessary, IRAAAAA
Interest is in thoughtful & deep answers
Outlining: Using analytical table of contents from book, use as skeleton.
Know when different statutes apply in different jurisdictions.
Know the important statutes.
Look up Sarbanes-Oxley
Don't be conclusory

I. Agency

A. Introduction
Text Outline

A sole proprietorship, as a matter of law, will have no separate identity from its owner although it may have a
separate financial and physical identity.

The employment by one person, P, of another, A, to act on P's behalf, and subject to her control, is known as the
Law of Agency. An agent is a person who by mutual assent acts on behalf of another and is subject to their
control, while the person for whom the agent acts is a principal. Agency law governs:
 The relationship between agents and principles
 The relationship between agents and third persons with whom the agent deals on a principles behalf
 The relationship between principles and third persons when an agent deals with a third person on the
principal's behalf
Agency is a legal concept which depends upon the existence of required factual elements: the manifestation by
the principal that the agent shall act for him, the agent's acceptance of the undertaking and the understanding of
the parties that the principal is to be in control of the undertaking. Whether an agency relationship has been
created does not turn on whether the parties think of themselves as or intend to be agent and principal.
Class Notes

Associations currently in existence, sole proprietorship, partnership, Public Corporation, LLP, LLC, Closed
Corporations and Limited Partnerships.

LLP & LLC are recent statutorily created developments, do not have a lot of case law on these two. Theory that
corporate law needs to function to regulate markets and externalities, not just a series of contracts between
parties became dominant. Post ENRON regulatory doctrine has gained ground in corporate law.

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Areas Influencing Corp. Law Theory
Three sources of doctrine in BA:
 Federal Law - Securities laws, but influential in Corp law in general
 Statute Law - Corp legal models
 Restatements - Professors ideal views on Corp law.

Three Corp legal models:

 Delaware Model
 New York Model
 Model Business Corp. Act

Choice of business form. Extremely determinative in choosing which form is the Tax impact.

B. Authority
Text Outline

Dawn v. Morris Hypo: Undisclosed agency principal.

It is well established that an agent for an undisclosed principal subjects the principal to liability for acts done on
its account if they are usual or necessary in such transactions. This is true even if the principal has previously
forbidden the agent to incur such debts so long as the transaction is in the usual course of business engaged in
by the agent; i.e. contract documents need not bind third parties who deal with one of them in ignorance of
those instructions.

Agent: Person who acts on behalf and is subject to control of another.

General Agent: Agent authorized to conduct a series of transactions involving continuity of service.
Special Agent: Agent only authorized to conduct a single or limited series of transactions.
Principal: Person on whose behalf and subject to whose control the agent acts.
Disclosed: Agent whom a third party knows the agent is acting on behalf of principal.
Partially Disclosed: When third party knows agent is acting on behalf of a principal, but does not know
principals identity.
Undisclosed: Principal is undisclosed if the agent, dealing with a third party, purports to be acting on its
own behalf.

Principal will be liable for agents authorized activities as (1) principle sets the transaction in motion and stands
to gain from it, and (2) third party can sue the agent who can indemnify the principal so allowing liability does
not materially enlarge the principals liability.

Liability of Principal to Third Person: Under the law of agency, a principal becomes liable to a third person
as a result of an act or transaction by another, on the principals behalf, given actual, apparent, or inherent
authority, or was an agent by estoppel, or if the principal ratified the act or transaction.
Actual Authority: An agent has actual authority to act on the principals behalf if the principals words or
conduct would lead a reasonable person the believe he had been authorized by the principal. Can be
express or implied.
Apparent Authority: An agent has apparent authority to act in a given way in relation to a third person if
the words or conduct of the principal would lead a reasonable person to believe that the principal had
authorized the agent to so act.
Agency by Estoppel: A person who is not otherwise liable as a party to a transaction, is nevertheless
subject to liability to persons who have changed their positions because of their belief that the
transaction was entered into by or for him, if (1) he intentionally or carelessly caused such belief, or (2)
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 knowing of such belief and that others might change their position because of it, he did not take
reasonable steps to notify them of the facts. Similar to apparent authority.
Inherent Authority: Under this doctrine agent may bind a principal even when the agent had neither
actual or apparent authority. Applicability is murky but under §161 Restatement the principal may be
liable, even if agent is forbidden, if (1) the act usually accompanies or is incidental to transactions that
the agent is authorize to conduct, and (2) the third person reasonably believes the agent is authorized to
do the act.
Ratification: A principal will be bound to a third person if the agent purported to act on the principal's
behalf, then with knowledge of the facts, either (1) affirms the agent's conduct by manifesting an
intention to treat the agent's conduct as authorized, or (2) engages in conduct that is justifiable only if he
has such an intention. Ratification need not be communicated to the third person to be effective,
although is must be objectively manifested.
Acquiescence: If the agent performs a series of acts of a similar nature, the failure of the principle to
object to them is an indication that he consents to the performance of similar acts in the future under
similar conditions.
Termination of agents authority: The general rule is that the principle has the power to terminate an
agent's authority at any time, even if doing so violates a contract between the principle and the agent and
it was agreed that authority was irrevocable. This rests on the ground that personal services will not be
subject to specific enforcement.

Liability of Third Person to Principal: The general rule is that if an agent and a third person enter into a
contract under which the agent's principal is liable to the third person, then the third person is liable to the
principal. The major exception is that the third person is not liable to an undisclosed principal if the agent or the
principal knew the third person would not have dealt with the principal had they known their identity.

Liability of Agent to Third Person: Where the agent has actual, apparent, or inherent authority, so that the
principal is bound to the third person, the agent's liability to the third person depends on whether the principle
was disclosed, partially disclosed, or undisclosed. If undisclosed, the general rule is that the agent is bound,
even though the principal is bound too. If partially disclosed, the general rule is that the agent as well as the
principal is bound to the third person. If disclosed, if the principal is bound by the agent's act, the general rule is
that the agent is not bound to the third person.

If the principal is not bound by the agent's act, because the agent did not have actual, apparent, or inherent
authority, the general rule is that the agent is liable to the third person. Liability is usually based on the implied
warranty of authority theory, but some authorities apply the theory that the agent can be held liable on the
contract itself. Difference being that under the 'liability' theory, expectation damages could be collected while
under 'implied warranty' theory only losses suffered by entering the contract could be recovered, or reliance
damages.

Liability of Agent to Principal: If an agent takes an action that they have no authority to perform, but if the
principal is nevertheless bound because that agent had apparent authority, the agent is liable to the principal for
any resulting damages.

Liability of Principal to Agent: If an agent has acted within their actual authority, the principal is under duty to
indemnify the agent for payments authorized or made necessary in executing the principal's affairs.
Class Notes

When drafting legal document need to be very wary of what language and drafting will possibly freak out the
other side and scuttle the deal. Good drafters can read the other side and work around or avoid these issues. Also
need to let clients know of the possible pitfalls of an agreement. Need to act in a way to maintain the interests
6
and relationship between the parties, but be open about issues of conflict. Courts will look at your document to
decide what parties intended, but your drafting can help shape intentions as parties intentions are not necessarily
fully realized or understood at the beginning of the relationship.

Actual Authority: If a P appoints an agent, P agrees to be bound as P would have been bound if they had entered
into directly. There can be both express and implied actual authority. Implied/incidental authority is tasks that
need to be completed to conduct the assigned task, would be considered to have been implied authority.
Restatement says that it will be looked at what a reasonable agent would have thought they had authority to
perform. Reasonableness test would also apply when circumstances change and the agent is aware. Always
about manifestations from P to A, not necessarily third parties.

Courts have said though that P can not put to A all the authority vested in P. Can not give agent complete
authority.

Ratification: If the principal has accepted the benefit with knowledge of relevant facts of the contract, even if
not fully authorized, P will be bound to A's actions. Can also be express or implied. There should be at
minimum an implicit acceptance, but also can have ratification if the principal accepts the benefits of the
agreement, even if unauthorized.

Apparent Authority: Important is that view is based on what would be a reasonable interpretation of the agent
of what their expectations are. Nothing in restatement defines what a reasonable expectation is, go to case law.
Can have apparent authority without actual authority and visa versa. Must be a disclosed principal in order to
have apparent authority.

Estoppel Authority: Estoppel is tort doctrine, very close to apparent authority. Here you are saying that the
principal is denied from estopping the authority of the agent. Estoppel can help when you can't establish agency
so contract theory does not work. Damages can also work differently in estoppel vs. contract.

Inherent Agency Power: When have undisclosed principal by definition there is no apparent authority. Can have
IAP when principal is undisclosed as third party would have no need to go through an agent, but deal with
principal themselves and should not be held liable for agreements for which they may not be aware. The
limiting factor on what a principal is liable for when undisclosed agent acts outside of trade norms they will not
be held liable, can also be social restraints.

Morris Oil v Rainbow Oilfield

FACTS: Morris Co. sues Dawn Co. for collections due to unpaid fuel bills incurred by Dawn partner, trucking
operator Rainbow. Morris tracks down Rainbow for payment and learns of Dawn escrow account, where they
are told by Dawn that they will be taken care of.
ISSUE: If Dawn is liable for bills incurred by its partner Rainbow, incurred during the regular course of
business, in supposed violation of the contract not allowing it to incur debts.
RULE: Under the principle of Undisclosed Agency Morris could not have been aware of the terms of the
agreement between Dawn and Rainbow, thus their dealings with Rainbow were as one could expect and in the
normal course of business. Furthermore, Dawn collected the receipts and was thus aware and retained benefits
from its agency relationship when dealing with Morris. It is clear that Dawn ratified the open account after
learning of it's existence when Morris contacted Dawn regarding payment. Shirley, was an agent with implied
authority to Morris.
NOTES: Agreement specifically states there is no agency between Dawn and Rainbow, but their actions
implied ratification. Court makes leap that all of Rainbows liability is now Dawns liability, but conversations at
best ratified Dawns acceptance that Morris would get paid out of Rainbows liabilities. Court seems to say that
in accepting clerical fee they accepted benefit of contract but this is not the case as fee was already in place.
Court also makes the assumption that installing a bulk dispenser is in the ordinary course of business, but this is
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an arguable point. Dawn is also an undisclosed principal in this case

Matter of Allender Company

FACTS: Securities broker, Binder, was informing his customers that he was not accepting any commissions. He
then proceeded to sell securities at a cost well above the quoted market values. Respondent claims he owes no
duties to disclose profits and is free to conduct these transactions.
ISSUE: Whether the relationship of the respondent and his customers was one of agent/principal requiring a
duty of disclosure.
RULE: The SEC found that certain obligations arising out of this relationship were due on the part of Binder,
that there was an agent/principal relationship. he could not deal with his customers as an adverse party without
their consent, and that he had a duty to disclose all material facts, and failing to do so was fraud. Protective
language in the transaction confirmation did not overcome the fiduciary relationship.
Question to SEC, was this an arms length sales relationship or a fiduciary agency relationship? SEC looks at
conflicting express words of sales agreement vs. the representations of Binder, unequal bargaining relationship
and decides that there all factors favor the widows and is an implied relationship.
What if there were two innocent parties hurt or conflicting agency relationships? Comes down to judicial
discretion based on expectations of the parties as nature of relationships.

C. Duty of Loyalty
Text Outline

In a case where a servant enriches himself by taking advantage of the position he occupies, any profits are due
to the master, even if no harm was done to the master, as gains were solely by the position he occupied.

There are costs involved in the monitoring of agents, defined as:

 The monitoring expenses by the principal
 The bonding expenditures by the agent
 The residual loss, or loss due to divergent interests/decisions
Class Notes

Agency is about represental relationships of all kinds, do not have to be written or exchange of consideration,
need to be nominally under control and working on behalf of another.

Liability
Restatement Sec. 1, page 6
Manifestation by P, Consent by A, and be under control of P. Needs to be a consensual relationship.
Agency Cost Problem: Problem with agents making mistakes or errors, possibly hire other agents to oversee
agents, leading to spiraling costs.

Trade practice restrictions should be sufficient to hold principal liable for actions of his agent without allow
them an "out" clause on contract terms, while at the same time limiting liability so that the use of agents does
not become excessively risky. Can't indemnify for apparent or unauthorized practices.

Eisenberg's foreseeability argument vs. trade practices view. Problems with the distinctions as it is hard to
predict whether this increases or reduces liability of principals.

Proposed restatement 3rd eliminates these distinctions.

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Fiduciary Duties
Choices are you can contract "out" of specific violations (fairness), no self dealing at all, court review, contract
"in" no self dealing. The restatement falls in favor of the K Out theory.

Absolute ban on self dealing when the subject is trusts, even if economic results are ridiculous. Absolute
prohibition on kickbacks and profits.

What if agent advises the principal of his actions? See Restatement S23, you need to reveal the existence and
extent of adverse interest, and Restatement S387 Unless otherwise agreed to by principal, agent is to act solely
for the benefit of principal. Illustrations pg. 31, any hidden dealings by agent that result in commission, that
commission is due to the principal.

S390 Disclosure. Agent has a duty of fair dealing with the principal. Need to disclose all fact that could or
reasonably could effect need to be disclosed unless principal manifests in some way that he is aware. If
principle is not business savvy, agent may not be relieved of duty to disclose even if principal expresses a desire
not to know.

If agent is paid need to exercise duty of care and skill, if unpaid there is no special agency based duty of care.

Termination of Agency powers, Ch 5 of Restatement of Agency.

Tarnowski v. Resop
FACTS: P engaged D as his agent to investigate and negotiate for the purchase of a route of coin operated
music machines. P purchased such business from sellers, P. Loechler and L. Mayer. P alleges that D represented
to him that he had done a thorough investigation of the route, when in fact he had investigated only 5 of the 75
locations. he also adopted false representations from the sellers and adopted them as his own. P discovered the
falsities and rescinded the sale after having paid an $11K down payment. Sellers refused to return his down
payment. Upon suit P received a $10K judgment. P filed suit against D alleging D received a secret commission
from sellers, and damages for losses.
ISSUE: Whether principal can recover damages from agent due to self dealing misdeeds on his part.
RULE: Actual injury is not what the law proceeds on, but fidelity of the agent is what is aimed at. Thus a
principle can recover from his agent any benefit resulting from a violation of his duty of loyalty, which would
have been profits due the principal, the principal is entitled to recover from him even if he has been made whole
again. Principal is also indemnified by the agent for any loss which has been caused to his interest by the
improper transaction. Also, it is generally held that where the wrongful act of the defendant involved the
plaintiff in litigation, he is entitled to recover the costs as damages.

Kidd v. Thomas Edison

FACTS: The issue is whether an agent, Fuller, had authority to contract with Thomas A Edison Inc. (D) on
behalf of Mary Kidd (P) to engage her without condition to sing for a series of 'tone-test' recitals designed to
show the accuracy of D's records. D contends Fuller's only authority was to engage P for only the recitals
which he could book with record dealers. The dealers would pay costs, and D would guarantee performance. P
claims contract was for an unconditional singing tour, jury agreed. D instructed Fuller to learn what fees the
artists expected, and tell them that D would pay their expenses, act as booking agent, and see that the money
was paid.
ISSUE: What was the degree of Fullers 'apparent authority' as contrasted to the express authority given to him
by D, Maxwell.
RULE: That the scope of authority should be measured not by words alone, but also by the setting in which
they occur including trade custom. Estoppel was created by the trade setting in which singing recitals are
normally hired, without these conditions imposed.
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NOTES: Learned Hand is promoting his social policy here. LH relies on trade customs but the P is arguing that
the deal is different so it is hard to reconcile. LH says he is interpreting trade custom, he then uses analogy, this
way he gets to choose which custom to apply to a new business model. LH uses trade custom both to limit
liability in a new industry and to hold them liable if they take advantage of agents, or their agents take
advantage. Trying not to unduly protect reckless business' but not to reward improper behavior.

Watteau v. Fenwick
FACTS: A Brewery (D) who owned a beerhouse appointed a manager in whose name the business was
licensed. In their agreement the manager was forbidden to purchase certain goods, which were only to be
supplied by D. Manager purchased other goods, and upon discovery by this Brewery (P) they sued for the value
of the goods. Lower court held D liable even though manager was never expressly made an agent and exceeded
his authority. D argues that purchases were by manager on his own credit and it needs to be shown that he is an
agent in fact. P argues that manager was an undisclosed principal clothed with the authority to do business on
behalf of D.
ISSUE: Whether the doctrine of principal and agent applies given agent is undisclosed.
RULE: That when a principal is undisclosed, and the third party dealing with the agent is unaware of
relationship and conditions between agent and principal, principal will be held liable for actions of the agent
even if unauthorized as long as within standards of trade practice.

II. Partnership

A. Partnership Formation
Text Outline

Hilco Properties v. United States: It is immaterial that the parties do not call their relationship, or believe it to
be, a partnership, especially where the rights of third parties are concerned.

Arnold v. Erkmann: A partnership is 'an association of two or more persons to carry on as co-owners a business
for profit, intent to form a partnership is not necessary.

Notes On Formation of Partnerships

1. Corporations, limited partnerships, a limited liability companies can only be formed when certain formalities
are complied with an filed with the state, while partnerships can be organized with no formalities or filing.
2. A relationship will be considered a partnership only if four elements are present; (1) an agreement to share
profits, (2) an agreement to share losses, (3) a mutual right of control or management of the business, and (4) a
community of interest in the venture. This four element test departs from the statutory test of UPA and RUPA.
Class Notes

Partnerships regulated by UPA, Uniform Partnership Act and RUPA, or Revised Uniform Partnership Act.
Original theory was that partnerships should have separate legal standing. Problem with UPA is that when
Ames began drafting, he was a proponent of partnerships being separate, but he died and was completed under
an aggregate concept.

1990's movement to make UPA more in line with business processes. Not every state has adopted RUPA.
Florida adopted RUPA as FRUPA, need to know only the few differences between the two.

How do courts decide if a particular entity is a partnership? RUPA S 201 & 202. RUPA has explicit statement
that partnership is an entity, UPA is more complex. Partnership by estoppel is possible S 16 UPA. General
partnerships are very elastic forms of business ventures, no filing requirements, need to look at underlying

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statutes in jurisdiction for legal guidance.

How to Create Partnerships

Partnership must be by two or more persons as co-owners in the business for profit. Sharing of returns does not
necessarily establish a partnership, sharing of net-profits is prima facie evidence of partnership, with exceptions
listed. Regardless of what is stated in partnership agreement, courts may construe partnership based on actions
of parties, specific intent to do those things that constitute a partnership.

Share in profits considered one of the foundations necessary in partnership creation. Courts will look at whether
actions created an intent to create partnership, even if agreement states no partnership was intended to be
created.

Nothing in UPA or RUPA points to tax filings as determinative in any way in deciding if a partnership entity has
been formed. When things start heading south with the business the incentive becomes strong to try and
structure a party as a lender vs. a partner.

Martin v. Peyton
FACTS: John Hall, a partner in KN&K, obtained a loan of $500K of liberty bonds from his friend Mr. Peyton
to use as collateral. Mr. Hall offered a partnership to Mrs. Peyton along with Mr. freeman and Mrs. Perkins, all
refused. An agreement was reached though whereby they would loan KN&K $2.5M in securities that the firm
could use as collateral. To ensure against loss, KN&K was to turn over securities to the lenders that was to
speculative to use as collateral for the bank. Additionally, they were to receive 40% of the profits until the return
was made.
ISSUE: Whether these transactions and contract provisions associate respondents with the firm so that they and
together thereafter carried on as co-owners a business for profit?
RULE: The court found that the provisions for a share of the profit, collateral, an insurance policy on Mr. Hall,
and certain control provisions including right to have a say in the termination of a partner were taken together
not sufficient to have formed a partnership.
NOTES: Partnership results from contract, express or implied. If nothing else appears the receipt by the
defendant of a share of the profits of the business is enough. Market created creditor protections with negative
controls. Intention will be scrutinized by courts, here a life saving loan, both as it relates to the transaction at
issue and effects business conditions as a whole. Here no bankruptcy provisions so a social policy of allowing
customers to add equity in the form of a loan to try and save their business and previous investment.
Pro Partnership Prov.: 40% profit share, Inspect books, PPF consulted on important matters, PPF obtained
resignations of partners, No loans to partners.
Pro Loan Prov.: Option to be partnership, floor/ceiling on profit sharing, Hall is manager, PPF has only veto
power, Language of agreement.

Lupien v. Malsbenden
FACTS: Plaintiff entered into a contract with Cragin, as part of York Motor Mart, for construction of a custom
auto putting down $500 and further payments of $4K. Plaintiff never received his vehicle. Malsbenden claimed
his relationship to York was only that of a banker, with the interest free loan to be repaid from sales of the autos.
Cragin left town but Malsbenden continued to operate the business.
ISSUE: Whether the superior court erred in its finding that Malsbenden and Cragin were partners in the
pertinent part of York Motor Mart's business?
RULE: The court found that Malsbenden's day to day involvement in the operations, and dealings with third
parties, constituted a partnership having been formed even if not contractual.
NOTES: $85K here used as working capital vs. a fenced off loan as in Martin. Malsbenden retained complete
control here of the operation which further leans towards partnership structure.

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 B. Legal Nature of Partnership
Text Outline

Entity v. Aggregate: The common law view is that a partnership is not an entity, but merely an aggregate of its
members, so that a partnership was no more a legal person then a friendship. The drafting of the UPA began
with an entity theory, was completed using the aggregate theory, so it deals with many issues as if a partnership
is an entity. Even though defined as an association (aggregate) under the UPA, legislatures may choose to treat
as an entity for purposes of statutes. RUPA confers entity status on partnerships. The UPA withheld entity status
from partnerships then created complex rules to arrive at entity results, while RUPA is able to drastically
simplify many partnership rules. In some areas RUPA reaches an aggregate like result, most notably as in UPA a
partner remains individually liable for partnership debts and a partners duty of good faith and fair dealing
extend to both the partnership and other partners.
Class Notes

UPA S16 Partner by Estoppel. Smith v Kelley has partner by estoppel, but party is apparently getting none of
the benefits of partnership.

Hypo pg. 43: B & C prevail, though they have the least stake in the business due to the presumption of equality.

UPA: Any extra-ordinary action requires unanimity, made clearer in the RUPA. Why is there an assumption that
all share equally in the decisions even though assets contributed might be unequal?

C. Operation of Partnerships
Text Outline

Though the general rule is that partners have an equal say in partnership operations, this can be altered by
agreement or by conduct. When not formally in writing, partnership agreements consist of the fragmentary
explicit and implicit agreements made from time to time. Unanimity is required do depart not only from formal
agreements but fragmentary ones also. UPA 18(e) grants even minority partners a right to be consulted in
management decisions, even if his assent is not required.

National Biscuit v Stroud

FACTS: Stroud and Freeman were partners to sell groceries, Plaintiff regularly sold bread to partnership.
Defendant advised Plaintiff that he would not be liable for future bread sales to partnership. Freeman ordered
bread just prior to dissolution of approx $171.
ISSUE: Whether Freeman's purchase bound Stroud.
RULE: Yes, as equals in the partnership both men had a right to manage the normal course of business, and
both are liable for the purchases.
NOTES: Why is Stroud left liable? The assumption is one partner can not veto decisions of a partner. Can not
put that high a level on inquiry duty on a third party, and is questionable whether the notification to Nabisco
was accurate. One partner can not take another partners authority away unilaterally, actual authority of an agent
will not be eliminated. How to protect yourself from partner? Just dissolving not enough according to UPA as
you need to notify creditors. UPA then defaults to dissolution of business as remedy in deadlocked decisions.
Can try such things as arbitration and formal separation of functions to relieve deadlock.

Sanchez v Saylor
Sanchez and Saylor were partners, a third party was going to lend money but Sanchez refused to provide his
personal financial statements. Saylor sued for breach of fiduciary duty, court found in favor of Sanchez. Partner
12
refuses to provide personal financial statements so loan is not given and partnership goes bust. Taylor sues for
breach of fiduciary duty. In Covalt one party has 75% of the stock as a differentiator. Covalt rule is that each
partner has an equal say in decisions, and appropriate remedy for disagreements is dissolution. Covalt rule
might be correct in situation with no self dealing, but here we have a self dealing relationship.

Indemnification and Contribution

Partners are individually liable to partnership creditors for partnership obligations, as between the partners
however, each partner is liable only for his share of partnership obligations. This if a partner pays an obligation,
he is entitled to indemnification from the partnership for the difference between what he paid and his share of
the liability. In a proper case, the partnership has a right to require contribution from one or more partners, thus
the obligation to indemnify a partners a partnership liability, and the obligation to make a contribution is a
liability of a partner.
Class Notes

Unless partnership says otherwise majority rule will win. In two person or deadlock position
Summers/Nabisco/Sanchez approaches to resolving the dispute will govern. Is it possible to end run UPA
S18(h) by arguing fiduciary duty? Probably not, but can differentiate the cases. UPA S18(e) provides for all
partners to be included in all decisions and information, i.e. right to be consulted, so you can have a violation of
18(e) which is not necessarily a violation of 18(h) dealing with decisions. RUPA is the same as UPA on these
subsections.

Should courts look at informal actions of the partners, or strictly read 18(h)? First thing you look at is written
agreement, second would be a course of dealing between parties, and 18(h) remains the final default to be
looked at by the courts.

It is not economically rational to have a 90% investment in a partnership but have decision making rules of
50/50 for two person partnerships and majority rule for three or more. Creates incentives for low equity investor
in bad position to cheat.

No equality assumption in UPA with profits and losses. If agreement states profits will be shared a certain way,
court will find losses shared the same way and not go to UPA default.

Courts have said that there is an implied agreement that when one partner is a services only partner he will only
share in losses to the extent of his investment generally, not up to statute requirements. Literal application of
statute services only partner would share equally in cash losses of partnership. Some strict proponents of
following statute point to lost opportunity cost of investing the funds on the part of the equity investor. Courts
will also imply an agreement of equality of evaluation, but when services partner is compensated he will always
have to share in the profits.

UPA S18(h): No partner is entitled to compensation by the partnership, same in RUPA.

Remaining partner is entitled to compensation though in UPA for the act of winding up the closure of the
partnership.

Summers v. Dooley
FACTS: Partnership agreement to operate trash collection business. Dispute between two partners about one
hiring an additional employee without the consent of the other, but is seeking reimbursement from the
partnership or other partner. He argues that the other partner is sharing in the profits and consented by action.
ISSUE: Whether an equal partner in a two man partnership has the authority to hire a new employee in
disregard of the objection of the other partner and then attempt to charge the dissenting partner with the costs
13
incurred as a result of his unilateral decision.
RULE: The court cites that equality between partners is with respect to management of business affairs is a
central theme in Uniform Partnership Law and that ordinary matters must be decided by a majority of the
partners.
NOTES: Lower court says that you can not have a majority with a two person partnership so no liability for
compensating hired employee. Could have used a ratification argument to possibly sway the court.

D. Authority of a Partner
Text Outline

The basic rule governing a partner's actual authority under the UPA is that each partner is an agent of the
partnership for the purpose of its business. The major difference between UPA and RUPA concerning
partnership authority is that RUPA § 301(1) makes clear, unlike UPA, that a partnership is bound by an act of
the partner for apparently carrying on in the usual way, (1) the partnership business, or (2) business of the kind
carried on by the partnership.

RNR Investments LP v Peoples First Bank

Agreement required general partner to prepare a budget covering costs of acquisitions and constructions.
Partnership obtained notes for project in breach of agreement, after some time partnership defaulting claiming
that Bank should not have issued the notes. RUPA provides greater protection then UPA to 3rd persons dealing
with partners. RUPA can protect partnership from rogue partner by; (1) allowing for notification to 3rd party,
and (2) allows partnership to file a statement of partnership authority restricting partners authority. Issue is did
the Bank have notice as the general partner was acting in his normal course of business? No, there was no duty
for the Bank to have to inspect the partnership documents. The partnership should have protected itself by
giving the bank notice or filing a statement.
Class Notes

Knowledge Exception
Obligation to do some investigating under UPA to see if partner has authority. Under RUPA court rules third
party would need to have been given information, more third party protective. Assumption that in real estate
transactions title is on file so assumption is easily discoverable.

S 301: Lewis theory wins out, RUPA much more third party protective then UPA.

E. Liability for Partnership Obligations

Text Outline

The provisions of UPA governing liability for partnership is an amalgam of the entity and aggregate theories.
UPA §§ 9, 13, 14 make "the partnership" liable for defined acts of the partners, however the UPA does not
authorize suit against the partnership to enforce these liabilities as the partnership is not an entity. To remedy,
the UPA goes to the extreme and under § 15(a) makes partners jointly and severally liable for wrongful acts,
torts and breaches of trust, however, § 15(b) makes partners only jointly liable for all other debts and
obligations of the partnership. Some states have remedied this by adopting "common name statutes" allowing
partnerships to be sued in their own name. Unlike UPA, RUPA § 307(a) specifically provides that a partnership
may sue, and be sued in its own name and § 306 provides that partners are jointly and severally liable for all
obligations of the partnership. RUPA provides protection in § 307 by providing that a judgment against a
partner based on a claim against the partnership normally cannot be satisfied against the partners individual
assets until partnership assets are exhausted. Thus joint and several has a slightly different definition under
RUPA then in the common law sense.
14
Davis v Loftus
Davis complained two lawyers committed malpractice in connection with a real estate transaction they engaged
in. Partners were both income partners and equity partners. Court held that income partners could not be held
liable as not partners under the UPA.
Class Notes

Under UPA partnership is aggregate so need to sue each partner jointly for contract disputes. RUPA does not
separate tort/contract and allows joint and several liability. UPA S 13, 14, 15.

Burns v. Gonzalez: Should not allow one partner to make lawsuit settlement decisions for entire partnership.

F. Partnership Interests and Partnership Property

Text Outline

Note on Partnership Property

Property used by the partnership may be either partnership property, or individual property loaned to the
partnership. The issue may be important in determining; (1) who has the power to transfer the property, (2) in
deciding between creditors when creditors of the partnership are competing with creditors of an individual
partner and ownership is at issue, and (3) if the partnership is dissolved determining which are partnership
assets. If the aggregate theory is strictly applied, a partnership can not own property, property would be held in
joint tenancy by each partner. To resolve this UPA treats the matter of partnership property as if it were an
entity. Through assorted legal mechanisms, § 25(1) & (2a-e) strip all incidents of individual ownership and vest
them with the partnership. RUPA § 203 already treating partnerships as entities, provides that property acquired
by a partnership is property of the partnership and not the partners individually. In addition § 501 explicitly
abolishes the UPA concept of tenancy in partnership.

Note on Partnership Interests

Partners Interest: Although under the UPA a partner does not own property in the partnership, he does own an
interest in the partnership. In practice, there is a two level ownership structure where the partnership owns that
assets, and the partners own the partnership.

Assignment: A partner can assign his interests, or profits, but can not assign his partner function without consent
of all the partners. A partner can not then sell his partnership, and creditors cannot levy in such a way as to
substitute a partner.

Partnership Creditors: A creditor that has extended credit to an individual rather then the partnership is in a
position similar to an assignee and can get a charging order on the partnership interest. The creditor can
foreclose that partnership interest under § 28, causing its sale, put the individual partner into bankruptcy,
resulting in dissolution of the partnership under § 31(5).

Priorities: A major problem in partnership law concerns the relative priorities of creditors of the partnership and
creditors of the partners as individuals. UPA § 40(h) provides that; (1) partnership creditors have priority over
separate creditors as to partnership assets, and (2) separate creditors have priority over partnership creditors as
to the individual assets of the partners. The rule was criticized as it kept partnership creditors from getting the
full benefit of personal liability of the individual partners. The bankruptcy code eliminated this priority rule, and
RUPA dropped it to keep in line with the bankruptcy code.

in re Gerlach's Estate
Since real estate was purchased with partnership funds, it became partnership property.
15
Balafas v Balafas
The action is brought for an accounting seeking to establish that certain property acquired jointly by two
brothers constituted partnership property and that one half belonged to the estate of Michael Balafas. Is the
property acquired by the partnership and its proceeds then estate property to go one-half to the deceased wife,
despite the wishes of the deceased that they go to his brother/partner. Court rules that as it was their intention
through their actions that the partnership property be left to the other partner upon death that will shall govern.
Class Notes

Intent of parties will be key in determining whether assets were meant to be included in partnership.

UPA S 8.1 states property purchased or brought into the partnership will be presumed to be part of the
partnership, unless UPA S 8.2 which states if the contrary intention appears. UPA S 8.2 states property
purchased in the name of the partnership is partnership property, so it would likely be immaterial whose money
is used provided it is in the name.

Presumptions: Purchased in partnership name it is partnership property, if partnership funds are used.

Don't want to allow an individual partners creditors to undermine the business by attaching individual partners
assets. UPA S 25 states that an estate is created and property becomes part of estate. RUPA S 501 does not need
this fiction and specifically repeals UPA S 25(1). RUPA S 502 states that a partners only interest is partners
interest in the partnership.

Rappaport v. 55 Perry
FACTS: Two families entered into partnership, each family having a 50% stake. Members of one family then
assigned 10% of their share to their adult children. The other family refused the request taking the position that
the partnership agreement did not permit new partners without unanimous consent. Plaintiff brought action
seeking declaration of their right to assign their interest in the partnership.
ISSUE: Whether a party can assign their partnership interests without unanimous consent of the other partners.
RULE: Court held that pursuant to the agreement and partnership law, consent of defendants was required in
order to admit additional partners into the partnership.
NOTES: Plaintiff did wish to have new partners included as that would shift majority shareholding to the
defendant. Courts ruling is a narrowing of the provision under the UPA. Real issue here is whether the children
can be brought in and be given decision responsibility. What is the courts jurisdiction in restricting who is
allowed to come into the partnership? UPA S 28 states you can't cut out creditors from garnishing partnership
proceeds. Very little case law on the issuance of charging orders. It would not be proper for one partner who
gets in a tough financial condition to have his creditors attempt to force liquidation of the partnership to get
payment, so the UPA allows for the other partners to buy out the debt and salvage the partnership business. If
partnership sued as a whole, joint liability not joint and several. Charging order procedure allows partnership to
pay for individual partnership.

G. Duty of Loyalty
Text Outline

UPA § 22 provides a right to an accounting: (1) when a partner is wrongfully excluded from the business, (2) if
the right is granted under the partnership agreement, (3) for appropriation of an unauthorized benefit in
violation of § 21, or (4) whenever other circumstances render it just and reasonable. As this course breeds
mistrust dissolution of the partnership is often the better course. UPA § 13 seems to restrict partners from suing
the partnership for recourse. There are exceptions though such as when equity and justice would demand a
settlement rather then accounting or dissolution. RUPA § 305 drops the language and allows a partner to sue the
16
partnership.
Class Notes

UPA S 21 is core provision, duty of loyalty along with S 18-20 laying out informational duties to partnership.

Section 404 RUPA, pg 154: Fiduciary duties of partner to partnership. Gross misconduct, reckless conduct
equate to a breach of duties. 404(e) self-dealing does not necessarily mean a breach of fiduciary duties. In S103,
pr 125 you can contract out of specific items that are duties of loyalty provided they are not manifestly
unreasonable. 404 was supposed to be a more realistic interpretation of what parties viewed their fiduciary
duties to be in practice. 404 has been under attack by both those that feel it gives to much leeway, and the
freedom of contract side that does not feel it is needed to give freedom of contract in code.

404 does not overrule Meinhard as the main rule from that case is the duty to disclose. Not possible for RUPA
to eliminate judicial discretion.

Meinhard v. Salmon
FACTS: Louisa Gerry leased to defendant Salmon the Hotel Bristol, which he planned to alter to shops and
offices for $200K. While negotiating with Gerry, he was simultaneously negotiating with Meinhard for funding,
resulting in a written joint venture. Upon expiration of the lease on the Bristol, Salmon renegotiated with the
assignee of Gerry for a larger tract, including the Bristol, to be redeveloped under a company separate from the
JV, but wholly owned by Salmon.
ISSUE: Whether Salmon breached his fiduciary duty to Meinhard when he entered into the new lease without
notice or opportunity to Meinhard.
RULE: Re-leasing the same property, without notice, and having used his position as manager to obtain the
deal Salmon breached his duty to Meinhard.
NOTES: The key case on partnership fiduciary duty. Joint venture, not partnership, but not terribly material
as at the time there were not major differences. Could have been a loan and not a partnership interest, but not
addressed by the court, likely due to loss sharing provision. Salmon needed the extra $100K for
additions/improvements to the hotel, but made sure he kept management control. Salmon sets up shell business,
Meinhard awarded a share of that business but that way ends up with share in other assets of greater value.
What exactly did Salmon do that was a breach of duty. Partnership can be construed broadly as being a real
estate JV, or narrowly as being a JV for the Bristol property. Cardozo seems to take the line of business
determination. Seems to point to a narrower duty of disclosure in that Salmon never disclosed any of his
dealings to Meinhard and never gave him an opportunity to compete. Question becomes was the deal offered a
partnership opportunity, and if so, was taking it effectively theft of the partnership and a breach of duty if the
nexus of the two opportunities is close enough. Cardozo finds that the venture came to Salmon strictly due to
his position as a fiduciary, and that by all appearance Gerry believed he was dealing with a sole entity.

H. Dissolution By Rightful Election

Text Outline

Distributions in Dissolution: UPA § 40(b) sets out the rules for asset distribution after dissolution. First priority
is to pay off creditors other then partners, the second is to pay partners for obligations other then capital or
profits, third is to pay off partners in respect to capital, fourth is to pay in respect to profits. Non capital partners
may be fund by the courts to need to contribute to losses if equity so require, similarly salary only partners may
share in the distribution of a capital partner if equity requires. Some courts hold that services partners in "joint
ventures" need not contribute towards a capital loss.

Page v Page
Plaintiff and defendant are partners in a linen supply business. Plaintiff appeals from a judgment declaring the
17
partnership to be for a term rather then at will. Court found that despite contractual language stating
"partnership profits will be retained until all obligations are paid", the partnership is at will and can be dissolved
at any time. The court warns though that should it be proved there was bad faith in the termination plaintiff can
be held liable.

Prentis v Sheffel: Stands for the prospect that in the dissolution of a partnership, when there is no breach of
faith, partners bidding in a judicial sale is completely acceptable and not contrary to the interests of a third
partner being excluded.

Breakup Under the UPA

The term "dissolution" is used in the UPA to describe a change in the legal status of the partners and
partnership, while "winding-up" is used to describe the economic event of liquidation. Broadly speaking, the
law attaches consequences to dissolution, (1) among the partners themselves, (2) between the partners as a
group and third persons, and (3) for tax purposes.

Consequences Among the Partners: Under the UPA dissolution simply means that a partner ceases to continue
being a partner, and that unless otherwise agreed the assets are sold and cash distributed. Continuation
agreements are common allowing remaining partners to continue the business.

Effect of dissolution on Third Parties: It is debated under the UPA whether a partnership agreement can provide
not only that the partnership business may continue after dissolution, but also that withdrawal of a partner will
not cause dissolution, son a partnerships relationship with third parties is not affected. The general answer is no.

Tax Consequences: Internal Revenue code § 708 provides that a partnership's existence does not terminate for
tax purposes until; (1) no part of any business, financial operation, or venture of the partnership continues to be
carried on by any of the partners in a partnership, or (2) within a twelve month period there is a sale or
exchange of fifty percent or more of the total interest in partnership capital and profits.

Levy v Nassau; Stands for the proposition that policy disagreements do not constitute bad faith.

Crutcher v Smith: Partners activities prior to the exclusion of a debtor partner were sufficient to show a
wrongful expulsion by those partners.
Class Notes

Words in UPA are counterintuitive in this section, dissolution, winding up, termination, continuation are all
used.

Change in relationship between the partnership may dissolve the partnership, but as partnership is considered an
aggregate, there still need to be actions to end the business operation, or wind it up. More of a disassociation of
the partnership that can either lead to liquidation, or to a continuation of the partnership under different
circumstances. Definition UPA S29, pg 108.

Have dissolution be decree of court, and different sections whether wound up or ongoing. In dissolution
provisions is the assumption that piece meal liquidation is a bad thing, but that is the final goal of the
provisions.

Many judges will not find dissolution of a partnership based of actions of the partners if the partnership is an
ongoing profitable entity, i.e. a so-of-a-bitch will not be forced to be dissolved by courts, UPA S32.

UPA S31 outlines rightful dissolution, UPA S32 identifies wrongful dissolution. A partner can just walk away
18
from a partnership, but considered wrongful dissolution and will have consequences.

Case strings in section define parameters for dissolution by lack of fiduciary duty, can read either narrowly or
broadly. Narrow reading seems to say that you can walk away at any time provided you don't steal value from
your other partner.

Girard Bank v Haley

FACTS: Mrs. Reid sent a letter of termination to her other partners in the partnership.
ISSUE: The issue is whether the letter caused the dissolution of the partnership.
RULE: Court ruled that there was no need to justify the termination as agreement did not specify any
requirements so that dissolution was not a contravention of the agreement.
NOTES: Court says there does no need to be justification for dissolution by a partner as an at will termination.
Letter sent terminating did not need to address reasons. Contrast with Page v. Page where there was an implied
promise for continuation of the partnership. Is there an obligation that a lender who is a partner not call in a note
as that will drive dissolution of the business.

Dreifuerst v. Dreifuerst
FACTS: Partnership operated two feed mills and there were no written articles of partnership. Plaintiffs served
the defendant with notice of dissolution of the partnership. The parties were unable to agree to a winding up of
the partnership. Lower court agreed to a sale by which existing partners could then buy the assets.
ISSUE: Whether, in the absence of a written agreement to the contrary, a partner upon dissolution and wind-up
of the partnership, can force the sale of the partnership assets.
RULE: Court ruled that dissolution envisions some form of sale, and there are no provision requiring an asset
split of an at will partnership, so that judicial sale is the appropriate means of dissolution.
NOTES: UPA S38, Rights of partners to application of partnership property, will differ depending on whether
dissolution is rightful or wrongful. Some cases say cash ok, some say payment in kind acceptable. S38(1) does
say that distribution should be in cash.

I. Dissolution By Judicial Decree and Wrongful Dissolution

Text Outline

Drastic consequences can result from a wrongful dissolution; (1) damages, (2) a valuation of interest that does
not reflect the real value of the interest because goodwill is not taken into account, and (3) a continuation of the
business without him.

There are two types of misconduct that may justify dissolution; (1) § 32(1)(c) refers to misconduct so serious
that it prejudicially affects the business, and (2) § 32(1)(d) misconduct relating to the partnership business that
makes it impractical to carry on the business with the wrongdoing partner. Courts may also order dissolution of
a partnership under UPA § 32(1)(f) when dissolution would be equitable.

UPA § 31(1)(d) allows involuntary expulsion of partners for "bona fide" reasons.

McGee v Russell's Executors

To prevent $15K to the brother from payment out of partnership proceeds, sisters claim Art 42 UPA the
partnership had continued. Court found that surviving partner did his fiduciary duty in winding up the business,
even though it was lengthy, due to the particular circumstances.
Class Notes

Partnership Breakup Under RUPA

Article 8 will apply when leading to bankruptcy, Eisengerg's forks in the road. RUPA provides for very
19
structured bankruptcy, includes a default rule.
S801 Winding up termination, pg. 179. Subsection (1) can force termination and liquidation. If not wrongfully
terminating partner can decide to just close and seek judicial sale of business, consistent with UPA. Not
consistent with UPA is that under the RUPA forks partner can change their minds under 802(b) as there is the
realization that dissolution can take time and circumstances change.

Read comments to S 801, especially i.

If 801 fork is not applicable you go to 701 fork, pg 171. Has buyout formula in subsection (b) which is a default
rule that can be contracted out of. If wrongful dissolution buyout will be reduced by the level of damages.
RUPA deals with liability issues differently if winding down then dissolution. Will find it easier to cut off
liability under RUPA then UPA. In buyout RUPA imposes reliance requirement on third parties, deems third
parties to have had notice 90 days after filing date of dissolution. Duty of inquiry greater under RUPA then
UPA. Material differences in language used, how share is calculated, agency power to bind after disassociation
and liability between RUPA and UPA. Good will problem in dissolution.

When drafting under RUPA can not totally draft out partner liability, and the more fundamental a waiver
provision the more the court will scrutinize the issue backing it up. i.e. will be hard to draft a partnership
agreement that cuts one of the partners out of a vote in major partnership decisions or right to withdraw at will
would not be able to draft out. Specific RUPA non-waivaible provisions are in 103 and 405.

Problem Set Handouts, Partnership Hypothetical's

1. Ars, Gratia and Artis. Ars is to receive $5K, seems that he is getting paid prior to other partners.
(a) Ars is liable in Tort action, joint and several liability in UPA.
(b) Artis is liable for contract, but likely read as contract issue so joint liability not joint and several.

2. Low loans 50K for 10 years. Is Low a partner? He has veto power and can decide whether he is in or out of
the agreement says yes. The fact that he is not providing services, just apparently a loan to the partners says no.
Partnership by estoppel section 16? Does it matter that he is being represented by the partnership? How is
consent defined? What is specific language that Gratia uses with the bank? She says she has an "interest" in the
business but does not specifically say she is a partner.
(b) Say he acted like a partner as bill was sent to him and he got paid, but he passed the bill on? He's not the
principle so he's not transferring the liability. Is there an estoppel issue with Mayer? Likely no, not much
information for analysis and no knowledge of partners that he shares in the profits so 18g issue as no consent.

3(a). Can Gratia authorize the construction contract? Sec. 9 problem as you view from third parties perspective
who would believe he has apparent authority. Arguments against authority are not seemingly in the course of
business, selling sports equipment wholesale while this is a retail operation she seems to be including. We know
Gratia is does not have actual authority under any principals. But, the partnership may still be liable for his
actions due to apparent authority under Sec. 9 as viewed from third party's standpoint. Do not confuse Sec.9 &
Sec. 18 principles. Aggregate view of partnership, each partner is viewed as an agent of the partnership. Sec. 3
interpretation of knowledge.

4. First question is the agreement rightful or wrongful, at will. Likely to be found at will and will likely ask for
his share in cash? If will not request liquidation? Sec. 36, would not be any liabilities if he sells to a third party
so there are differences between sale and cashing out, Sec. 43.

5. Upon liquidation, no duty to do anything but wind up, but do have a duty to wind up. S41.7. S38 rights of
partnership to property. S32 Dissolution by decree of court if one of the partners becomes a lunatic, drug addict
or serious problem in conduct of life that is not specifically affecting the conduct of the business. Do not have to
give him goodwill under S32 as a wrongful dissolution, do need to buyout but can pay in payments unless party
20
being dissolved can show that immediate payment would not be a drain on the business.

6. If forced to keep your share in the business, but not controlling, upon dissolution you can choose to take
proceeds or continue in the shoes of her husband who she inherited from. Gratia is insolvent as well here. Ranks
above the creditors after the old one and before the new.

Drashner v. Sorenson
FACTS: Plaintiff and defendant associated themselves as co-owners in an insurance and real-estate partnership.
Plaintiff ignored his duties, got arrested, and demanded partnership funds for his own use after which both
parties moved to dissolve the partnership. Court found that plaintiffs actions caused a wrongful dissolution.
ISSUE: Whether the goodwill of the business should have been considered when calculating the value of the
partnership assets.
RULE: Court found that given the circumstances of the dissolution, the South Dakota UPA statute does not
require the calculation of goodwill in the dissolution.

III. Alternative Forms of Business Organizations

A. Limited Partnerships
Text Outline

Traditionally the predominant considerations in selecting a form of business organization has been taxation and
liability. Traditionally corporations provided limited liability and general partnerships limited taxes. Three new
forms evolved providing limited liabilities and taxes; (1) Limited Partnerships, (2) Limited Liability
Companies, and (3) Limited Liability Partnerships.

Limited partnerships are not new but have changed recently with changes in the law. The Uniform Limited
Partnership Act (ULPA) was adopted in all states but Louisiana, while the Revised Uniform Limited Partnership
Act (RULPA) has been adopted in many and was further revised in 1985. Unlike general partnerships, limited
partnerships are creatures of statute.
Class Notes

With general partnership each of the partners has liability of the other, Limited Partnerships specifically limit
liability. Turn of 20th century starting corporations needed special chartering which led to corruption and
favoritism in obtaining charters. LLP grew to allow partners not to have to incur debts of partnership, general
partner assumes liability and retains control. They are times when limited partner can incur liability, and general
partner can protect themselves.

Governed by 1916 Uniform Limited Partnership Act, by 1970's though you have large numbers of large entities
becoming LLP's due to tax advantages. Partnerships not taxed as they are not considered an entity. 1976 redraft
to RULPA, redrafted again in 1985 as RULPA again. Some states still under 1976 statues, others under 1985,
earlier 1916 has largely been replaced. Today, LLP are closer to corporations the general partnerships.

To form LLP, need to file a certificate, most statutes do not require that you have a limited partnership
agreement, but this is not practical. One of the major differences between 1916 & 1985 is what goes in the
agreement, do not need any information about capitalization or names of limited partners to allow flexibility.

There are times a general partner can become liable for the partnership, when the general partner takes control
of the business. Control was never well defined. Key difference is in 1985 RULPA much harder to get into deep
pockets of limited partner.
21
Need to know differences between 1976 and 1985 Acts due to different jurisdictions still following different
acts and big difference in the control issue. RULPA S303(b) is safe harbor material. Statute does not address if
you would be considered general partner if you perform some or all the provisions. In fact the limited partner
gets to be much more involved in the daily operations then a small shareholder. Limited partners can basically
replace and pick general partners, actively advise, act as an agent, wind up etc. and still not be considered a
general partner.

Gateway Potato Sales v. G.B. Investment Co.

FACTS: Gateway, a creditor of Sunworth, brought suit to recover payment for goods it had supplied to the
limited partnership including GB Investments LP in the suit as part owner of Sunworth. Articles stated GB
would not control or assume liabilities of Sunworth. Sunworth advised Gateway that it had a large financial
backer, GB, upon whose reliance Gateway sold large quantities of seed potatoes. Court finds GB to have had
extensive involvement in Sunworth's operations.
ISSUE: Whether the limited partner was exercising control of the business.
RULE: Court finds that the extent of involvement in the business by GB was sufficient to preclude granting of
summary judgment in their favor.
NOTES: Sunworth was general partner. According to statute liability is incurred by limited partner only to the
extent that third parties rely on their participation and control. Substantially like =/ reliance, Less then
substantially like = reliance. Actual knowledge requires direct contact by the court, is that reasonable? ROPA
S303 1985 takes away the substantially like test, have to have reasonable reliance based on conduct of the
limited partner. 1985 standard much harder for 3rd party to meet. Prevents unjustly enriching creditors from
going after deep pockets on which they had no reliance.

Gotham Partners v Hallwood Realty , Del. Sup Ct., 2002

FACTS: Guzzetti, a board member of the general partner, proposed a reverse stock split, unit option, and tender
offer. HGI board approved the transactions based on Guzzettis recommendations, bringing their ownership up to
29.7%. Gotham, a real estate hedge fund, owned 14.8% did not complain about the purchases but was denied
request to view HGI's books. Gotham filed suit in court complaining that HGI obtained control over the
partnership at an unreasonably low price, claiming breach of fiduciary duties by board.
ISSUE: Whether (1) contractual fiduciary duties of fairness in the partnership agreement applied to the disputed
transaction, (2) defendants HGI, Gumbiner and Guzzetti are jointly and severally liable for aiding and abetting
the breach, and (3) court has discretion not to grant rescission when plaintiff unjustifiably delayed seeking
remedy.
RULE: That a limited partnership agreement may provide for contractually created fiduciary duties
substantially mirroring traditional fiduciary duties that apply in corporate law. Defendants are wholly and
severally liable because the challenged transaction breached the entire fairness provision of the partnership
agreement.
NOTES: general principle of corporate law is that only a party to a contract may be sued for breach of that
contract. Elements for aiding and abetting a breach of fiduciary duty are: (1) existence of fiduciary relationship,
(2) fiduciary duty is breached, (3) defendant who is not a fiduciary knowingly participated in the breach, and (4)
damages resulted from the concerted action. In awarding damages a breach permits: (1) broad, discretionary and
equitable remedies, and (2) courts will not construe a contract as taking away other forms of appropriate relief.

B. Corporate General Partners

Text Outline

RULPA § 303(b)(1) explicitly recognizes that a corporation can be a general partner in a limited partnership.
Two basic types of taxation exist under the revenue code: (1) firm taxation where a business firm is taxable on
its income, or "double taxation", and (2) flow-through taxation where a firm is not subject to taxation and all of
22
the firms income, gains and losses are taxed directly to the firms owners eliminating double taxation.

Under IRS regulations any "eligible entity" can elect either flow through or firm taxation. Master Limited
Partnerships are publicly traded and cannot elect partnership taxation, being taxed as corporations. Subchapter S
corporations, small limited shareholder corporations, are taxed as partnerships with each shareholder receiving
their pro-rata share.
Class Notes

Corporate Limited General Partners, when a corporation is the general partner. Is this in the spirit of RULPA?
Courts said yes, the creditors can gain additional security from then general partner if they so choose. What
does this form due to the fiduciary relationship of the partnership?

Gotham Partners
Do not pay attention to the specifics of the transaction, what was he general partner trying to accomplish.
Charge is that general partner is enriching parent company at expense of limited partnership. Dictum in the case
is that not all fiduciary duties have been eliminated by structure, but the statute allows and does not prevent the
limiting of fiduciary duties. Standard is entire fairness, i.e. fairness of price and fairness of dealings. Statute
entire fairness seems to allow self dealing which is not allowed by common law. Whole thing hand on issue of
whether this is an issuance of new units or old units. Ruling failed to take into account that GP now has the
controlling interest. Court says you can not completely waive fiduciary duties by contract according to the Del.
Supreme Court, but can reduce or change.

Once you start waiving fiduciary duties in documents you must be very careful and draft the documents
exceedingly well. Aider and Abeter liability vs. Direct liability, aider and abeter has general fiduciary duty to
other partners, general partner is a entity and not a legal concept.

pg 254, 2001 pending proposed Uniform Limited Partnership Act. Reason for 2001 proposal is that due to new
forms of organization such as LLP & LLC are taking over so need to look at what is appropriate for limited
partners now. Likely family limited partnerships for estate planning reasons and as limited partners in larger
more sophisticated entities. Major difference in 2001 is that there is never liability in limited partner no matter
what level of control as they should be treated more like corporate shareholders.

in re USA Cafes, LP
FACTS: Plaintiffs are holders of limited partnership units in the purchase of USACafes by Metsa Acquisition.
They bring the action as a class action on behalf of all unit holders. Defendants are the Wyly brothers who hold
all the stock of the general partner of USACafes, and the board of directors, and Metsa. Charge is a breach of
duty of loyalty, that general Partner was not sufficiently informed to make a valid business judgment on the
sale, that unit holders were misled into believing that the sale would be put to vote of all unit holders and that
Metsa knowingly participated in the breach of duty. Directors defense is that duty of care and loyalty were only
owed to general partner, not limited partners.
ISSUE: Whether directors of a corporate trustee may personally owe duties of loyalty to trusts of the
corporation.
RULE: Court finds directors have a duty not to use control over a partnerships property to advantage the
corporate directors at the expense of the partnership.
NOTES: General Partners is Inc., Wyly Brothers owned 47%. Limited Partners Plaintiffs and Limited Partner
Defendants also. Issue was basically a kickback scheme. Defendants argue they owe fiduciary duties up to the
USA Cafe partnership only, not to the plaintiff limited partners. Judge Allan makes an analogy to trust law and
finds that general partner's have liability, cannot hide behind corporate structure. Group of partners using
corporate shell to do what they please. Law says it is a fiduciary relationship, so corporation owes a duty to
other partners. Allen comes down that duty against self dealing must be extended, but does not address and rule
23
that other fiduciary duties are to be extended.

C. Limited Liability Companies

Text Outline

Limited liability Company's, LLC's, are noncorporate entities that are created under special statutes that
combine elements of corporation and partnership law. Owners and members of LLC's have limited liability as in
corporations. LLC's are entities that can own property, and are either member-managed or manager-managed.
LLC's originally were partly shaped by tax rules allowing each LLC to choose it own characteristics.

Formation Articles: LLC's are formed by filing at the State office and state (1) purpose of LLC, (2) if member-
managed or manager-managed and the names of individuals, (3) duration of LLC.
Operating Agreements: This is an agreement among the members concerning the LLC's affairs and provides for
governance, capital , distributions, and admission/withdrawal of members.
Management: Most LLC statutes provide as a default rule that the LLC is to be managed by its members and
can be varied only by provision in the LLC agreement.
Voting Members: About half the statutes provide the default rule that members vote per capita, the other half by
pro-rata.
Agency-Powers: In most member-managed LLC's the authority of a member-managed LLC is comparable to
the apparent authority of a partner. In manager-managed LLC's authority is comparable to a manager of the
corporation, Members of a manager-managed LLC have no apparent authority to bind the LLC.
Inspection of Books and Records: Generally members are allowed access to books and records, some say must
be for proper purpose.
Fiduciary Duties: Largely unspecified in the statutes so it is expected to largely come from corporate and
partnership case-law.
Derivative Actions: Most statutes explicitly permit members of LLC's to bring derivative actions on the LLC's
behalf based on a breach of fiduciary duties.
Distributions: Most statutes default rule is that distributions are on a pro-rata basis according to member
contributions.
Member's Interests: A members financial rights include their right to receive distributions, to participate in
management (member-managed), and be supplied with information. Creditor can get charging order against a
members interest.
Liability: All statutes provide that members are not liable for the LLC's debts, obligations, and other liabilities.
Disassociation: Statutes vary on the termination of a members interests. Death, bankruptcy and lawful
expulsion are often grounds.
Class Notes

Taxes is the main driver in deciding which form of corporate structure to adopt. LLC & LLP keep the pass
through taxation structure, but limit the liability of the partners. Developed in Wyoming, FL second, but did not
convince IRS until 1998 to adopt tax structure. Concern about corporate characteristics, perpetual life, limited
liability, free transferability etc. Some jurisdictions were strict in which characteristics you can adopt, some
were very flexible.

In 1990's IRA adopted the procedure that you can choose the characteristics in "check box" and take the tax
advantage. LLC advantage over "subchapter S" is fewer foreign investment restrictions, unlimited amount of
owners. LLC & LLP allow partners to take greater control with limited risk.

Downside of LLC & LLP is state taxes, still may be treated as corporation and liable for state tax even if Fed.
tax exempt. Must look at jurisdictional differentiation between states when analyzing LLC & LLP vs. general
partnership. Read LLC statutes. Look at duration of LLC, whether documents need to be oral or written, etc.
24
Governance and management issues will be set out in the documents, can have membership managed or outside
manager run the firm.

Piercing the corporate veil in Corp. law is when for equitable purposes a court will hold an individual
shareholder liable. Rough rule is when shareholder is not keeping with the integrity of the corporate form, i.e.
fraudulent activity, commingling, using Corp. solely for tax losses. Big difference in LLC and Corp. is that you
do not have a live market for LLC shares like you would in Corp. form, 37 Suffolk 927. Courts will not allow
use of LLC form to freeze out and squeeze out partners that have no ability to sell or transfer their partnership
interests, as opposed to Corp. shareholders who can sell shares.

Bastan Case: Defense is that LLC structure allows partner to manage the business. Court pierces the veil,
hanging their hat on formalities. States that the legislature surely would have passed legislation preventing if
that was their intent. Court finds that a person who ignores the intended separation between individual and the
company ought to be no better off then the sole shareholder who ignores corporate obligations.

VGS Inc. v Castiel: When an LLC manager and member get together without notice to a third and still active
member that will be viewed as a breach of good faith.

PB Real Estate Inc v. DEM II Properties

FACTS: Plaintiff obtained a deficiency judgment resulting from a mortgage foreclosure against defendant.
Plaintiff attempted to satisfy judgment from any payments becoming due to the individual defendants as owners
of the LLC.
ISSUE: The extent to which an LLC liability shield protects the interest of a member of a LLC against a
judgment creditor when the basis for the judgment is an obligation unrelated to the activities of the company.
RULE: That LLC limited liability status raises no barrier to the satisfaction of such a judgment from the
member's interest in the company.
NOTES: Members never voted to have distribution in a member managed LLC, documents say no authorized
distributions. A personal creditor is going after a partners interest in the LLC, the main issue here being to what
extent does the LLC serve as a shield.

Hollowell v. Orleans Regional Hospital

FACTS: Plaintiffs allege they were laid off by defendants, ORH LLC, without proper notice in violation of the
provision of the Workers Adjustment and Restraining Notification act. ORH is an LLC whose members are
NORS and NLRHP, both partnerships. ORH shut down without providing legally required notice to employees.
ISSUE: Whether LLC's are subject to veil piercing doctrine.
RULE: That the "veil" of protection afforded ORH by its LLC form may be pierced if in fact ORH was
operating a the "alter ego" of ORH's members or the members were committing fraud or deceit on third parties
through ORH. Moreover, the veil provided by the corporate status of ORH's members may also be pierced in
like fashion.
NOTES: Should courts pierce the LLC veil in the same manner that they pierce the Corp. veil? As LLC do not
require formalities such as annual elections, keeping minutes or holding meetings these formalities need to be
excluded as grounds for piercing.

McConnell v. Hunt Sports Enterprises

FACTS: NHL contacted Columbus OH officials about starting a new franchise there, who contacted local
businessman Lamar Hunt. CHL LLC was formed to explore the franchise, with members being local
corporations, partnerships and individuals making a $25K outlay, total $100K. Arena was to be financed by a
sales tax issue that failed in balloting. Negotiations went sour with Hunt filing suit on behalf of CHL against,
COLHOC, another party formed to obtain the franchise but including two members of CHL.
RULE: Contract provisions may effect the scope of fiduciary duties.
NOTES: Language of the court looks at language a unambiguous contract interpretation. According to opinion
25
possible back door interpretation of fiduciary duties, i.e. one the LLC rejects an opportunity can a partner in the
LLC accept it individually. Depends on if you read fiduciary duty as a concept that can be contracted away
(contractarian), or has certain fundamental bases that can not be contracted away (Eisenberg).

D. Limited Liability Partnerships

Text Outline

LLP's are essentially general partnerships with one core difference, that the liability of a general partners is less
so in the LLP then in a general partnership. A partner of an LLP is generally not liable for all partnership
obligations, only those arising from their own activities, with the possible exception of those closely related to
the partner. Some statutes require a trade-off for limited liability in the form of insurance requirements or
segregated funds and that they be registered with the state.
Class Notes

Limited partnership which is itself general manager of an LLP is an LLLP (Limited liability Limited
Partnerships). Largely designed for professional organizations such as lawyers and accountants. Provides
protection against the negligence of other partners. 2nd generation of LLP's statutes also include protection from
contract liability. Protects you from a partners liability, but you can still be liable for your own liability.

Megadyne information Systems: Megadyne charged its law firm of breaching its fiduciary duty by not informing
claim statute of limitations had run, thus legal representation paid for was worthless. Issue is whether all
partners will be liable under the LLP structure or only attorney working the case. Court rules all three partners
might be liable.

Historically in order to LLP you needed to have an insurance requirement and annual registration. Both
requirements have largely been dropped, and liability extended to contract breach. Now a lot more uniformity
among states in LLP law, FL Statute. § 620. Everybody in the LLP can participate in the business to some
degree.

IV. The Corporate Form

A. Characteristics of the Corporation

Text Outline

The corporate form has generally been the choice for public companies and results from five central attributes;
(1) Limited Liability: Shareholders and managers are not personally liable for obligations
(2) Free transferability of Ownership Interests: Stock is freely transferable
(3) Continuity of Existence: The legal existence of a corporation is perpetual
(4) Centralized Management: Managed by professionals under direction of a board of directors,
stockholders do not participate
(5) Entity Status: Corporation is a legal Entity so can have rights in it's own name

Close Corporations, general partnerships, limited liability companies are the different forms of privately held
corporations.
Class Notes

Corporation important driver in economic development, specially chartered by the states to do specific
functions. Pres. Jackson implemented anti-corporate policies, challenged the special chartering and monopolies
26
being granted to corporations. Statutes developed to allow private citizens to form corporations so as to avoid
special chartering by governments. Articles of incorporation needed to be specific regarding their purpose and
capital requirements, later general articles of incorporation developed.

Page 100 - Characteristics

Assumption of professional centralized management, exact opposite of partnerships. Continuity of life also
opposite. Greater level of transferability, additional formal requirements governing creation and management.
Tax treatment is different. Close corporations are privately held, not traded on an exchange. Do these different
characteristics make a great difference? Answer is clearly there are benefits to being a corporation.

Substantive law of corporations is State law not Federal law. Delaware became the location of choice for 50-
60% of corporations seeking to incorporate. States have economic incentives to attract corporations. Original
author of book, Kerry, sought it was better to have a Federal law of corporations. Eisenberg feels that Delaware
has since responded and it is no longer a race to the bottom. Eisenberg's argument overlooks the influence of
large shareholders, the differences in the legal regime of Delaware. Also, in fact federalism has largely occurred
due to the influence on securities laws.

B. Selecting a State of Incorporation

Text Outline

A corporation can incorporate wherever it chooses, internal affairs are governed by the law where they choose
to incorporate. States often adopt friendly incorporation laws in order to attract the franchise fees that come with
incorporating there. Eisenberg goes into his race to the bottom shtick. Delaware remains preeminent in the filing
of corporate incorporations.
Class Notes

Delaware Corporate Law Ch 607 and Revised Model Business Corp. Act. (RMBCA) some of the more
influential legislation dealing with corporations. RMBCA governs in FL.

C. Organizing a Corporation
Text Outline

Once a decision has been made to incorporate, the next step is filing a charter or articles of incorporation with
the state official. The charter will specify the classes of stock and number of shares issued in each class. Types
of corporate financing are; common stock, trade debt (accounts payable), bank debt, bonds and debentures.
Generally bonds are secured obligations and debentures are unsecured, and governed by the indenture.

Once under way a board of directors is elected by shareholders. There are two basic mechanisms; one is that the
incorporators choose the board directors until the shares are issued, the other way is to name the directors in the
articles of incorporation. In a subscription agreement a would-be shareholder agrees to purchase a corporation's
stock when it is issued to him at some future date. Most statutes now provide that pre-incorporation subscription
agreements are irrevocable for a specified period of time unless all subscribers consent to a revocation.
Class Notes

Del. 103(c)(2) need to file articled in Del. and pay fee. Delaware approach is that shareholders have the power
to appoint directors, NY has the incorporator’s appoint directors.

Two types of equity financing, i.e. stock, including preferred stock, and debt financing. With debt financing you
need to get paid, not so with stock.
27
Common law preemptive rights were assumed, not the case anymore. Dividends are payments based upon some
apportionment of corporate earnings. Declarations of dividends are the sole obligation of the board of directors.
Conversion right is option granted a corporation to convert one type of security to another, set out as rights and
obligations of stock/debt. Redemption right is option granted corporation or shareholder, can call shares at any
time.

Stock is the most volatile type of security, so more risk more reward and control. RMBCA has eliminated
limitations on convertibility and relies on fiduciary duty. Preferred stock has been used as strategic tool in
poison pills. Dividend of preferred is usually cumulative, so preferred dividends get paid in full prior to paying
common stockholders. Main difference between preferred stock and debt is that debt always has a right to be
paid. Series are subclasses of stock, i.e. common A and common B.

Because of watered stocks Par Value was set as a limit to which the stock would not be sold below, early in
Corp. history to prevent fraud. Now statutes allow par and no par stock. Still relevant for accounting purposes.

D. Preincorporation Transactions by Promoters

Text Outline

Promoters help a newly forming corporation make contracts, bring together assets and superintend the steps
necessary to bring the corporation into existence. The general rule for liability is that when the promoter makes
a contract for the benefit of a contemplated corporation, the promoter is personally liable on the contract and
remains so even after the corporation is formed. A corporation that is formed after a promoter has entered into a
contract on its behalf is not bound by the contract, without more. After formation the corporation may be bound
by ratification, adoption or novation.
Class Notes

Corporation can take on a promoter contract by express, ratification, novation, estoppel means. If you have
ratification or novation can relieve promoter of liability, adoption itself does not.

E. Consequences of Defective Incorporation

Text Outline

McLean Bank v Nelson: The corporate form provides limited liability, and if a group of individuals has not done
the things necessary to secure or retain de jure corporate status, they will have no corporate protection.

Three requirements are typically cited for application of the de facto corporate doctrine; (1) a statute in
existence by which incorporation was legally possible, (2) a colorable attempt to comply with the statute, and
(3) some actual use or exercise of corporate privileges.

Estoppel differs with de facto corporate theory in that estoppel is effective mainly for the facts of a specific
transaction. De facto will normally have a greater precedential effect. The two theories differ in two important
ways in their application; (1) the nub of estoppel theory in such cases is that the third party has dealt with the
business as if it were a corporation, and (2) the would-be shareholders would not need to resort to the estoppel
theory if they could establish that their business had de facto corporate status.

Quo Warranto: Proceedings brought by the state to test corporate validity. Can fail if found to be corporation de
jure, or one where noncompliance is unsubstantial.

28
 Class Notes

Doctrine of de facto incorporation, why necessary when incorporation is so easy? Cases where there are bona
fide attempts to organize and negotiations and activities have been conducted under the corporate name in belief
that the corporation is in existence. Broader doctrine then estoppel.

Harris v Looney is model for the revised act. De facto approach differs from the RMBC in being less protective
of third parties. New approach need to show that there was an attempt to defraud. In FL as long as both parties
are aware that corporation is in formation there is no liability.

Cantor v. Sunshine Greenery, Inc.

FACTS: Plaintiffs brought suit for breach of lease against Sunshine Greenery and Brunetti. The trial judge
determined that plaintiffs were entitled to judgment against Brunetti individually on the theory that at creation
of the contract he was acting as promoter and at the time of contract Sunshine was not a legal corporation.
ISSUE: Whether there was a de facto corporation in existence at the time of the lease.
RULE: Court finds that the bona fide effort to file and the dealings with the plaintiff in the name of the
corporation fully satisfy the requisite proof of the existence of a de facto corporation, so the judgment against
Brunetti is set aside.

Harris v Looney
FACTS: Robert Harris sold his business to J&R Construction, articles of incorporation were signed but not
filed until two days later. J&R defaulted on note, Harris sued incorporators jointly and severally. Harris argues
that incorporators were jointly and severally liable for the debt because its articles of incorporation had not been
filed with the secretary of state's office at the time Joe Alexander, representing the Corp., entered into contract
with Harris.
ISSUE: Whether appellees had acted for or on behalf of J&R Construction when entering contract.
RULE: Court affirms the lower court ruling that Joe Alexander only is strictly liable.
NOTES: Model for the revised act.

F. Classical Ultra Vires Doctrine

Text Outline

Early on corporations needed to narrowly describe the activities in which a corporation could permissibly
engage, transaction outside that sphere of what was allowed were ultra vires. These actions were unenforceable
by, and against the corporation.
Class Notes

Ultra vires doctrine has fallen into disfavor due to corporations empowerment to do what it chooses and not
have to declare it's purpose at time of incorporation. Can view Corp. entity as shareholders being true legal
owner, purpose being shareholder wealth maximization. Would be used to ensure that corporations were
complying with their incorporation doctrines outlined in their charters. General incorporation has made doctrine
largely obsolete.

Goodman v. Ladd Estate Co.

FACTS: Plaintiffs sought to enjoin defendant from enforcing a guaranty agreement by a corporation in favor of
Ladd Estate.
RULE: Plaintiffs were found not entitled to equitable relief.

29
 G. The Objective and Conduct of the Corporation
Text Outline

Hu: Discussion on shareholder wealth maximization and market risk.

Dodge v Ford, 1919

Henry Ford, as majority shareholder, declared hi intent to stop paying special dividends in order to reinvest
these funds and only pay regular dividends. The Dodge brothers as shareholders brought suit, court ordered
payment of $19.3M in dividends. Court cited that the corporation is in the business of benefiting shareholders.

Virtually all states have now adopted statutory provisions relating to corporate contributions that are comparable
to Delaware's. Some reasonable relation to the corporate interest remains a necessary component.

Other Constituencies under Del. law

Unocal v Mesa: Court begins with the basic principal that corporate directors have a fiduciary duty to act in the
best interests of corporation stockholders. Second passage focuses on other constituencies, which was limited in
Revlon where they stated that they can benefit other constituencies provided they are rationally related to
benefits accruing to shareholders.
Class Notes

Dodge Case: Not reasonable for Corporation to make payments with profits other then dividends.

Can corporations make charitable contributions? Have been addressed statutorily, Del. § 3.02 pg. 674 addresses
and allows charitable contributions, but Barlow and Del. statute state that it need not be directly in the corporate
interest but must be reasonable and in its interest. Milton Friedman states that corporations need to conform to
basic rules of society embodied in law. Arguments against donations are that it is shareholders money,
arguments for is that it can still benefit the organization indirectly and through taxes.

Delaware does not have "other constituent" statute to protect interest of employees, debt holders vs.
shareholders. These statutes allow directors in a hostile environment to take actions not purely in shareholder
interest in these instances.

Credit Lyonnais: Del. court states that it is ok for the directors of a company to diverge from the interests of the
shareholder, looking at general corporate interest. Is this only applicable when a corporation is near bankruptcy?

Unocal: Court tilts towards allowing managers to take defensive actions when faced with a corporate takeover,
can consider nonshareholder interests. Can go as far as justifying defense based on simply differences between
corporate cultures of organizations.

A.P. Smith Mfg. Co. v. Barlow

FACTS: AP Smith Co. donated $1,500 to Princeton which was challenged by shareholders. AP argued that this
was a sound investment and that the public expected corporations to give philanthropically.
ISSUE: Whether the statute allowing for corporate donation is effective.
RULE: The court find the donation to be within the lawful exercise of the corporations implied and incidental
powers under common law principles and that it came within the express authority of the pertinent state
legislation.
NOTES: Can read narrowly as a cold war response, or broadly as a representation of the desired business
philosophy in the US.
30
 H. The Nature for Corporate Law
Text Outline

Jensen & Meckling formulated the theory that the corporation is a nexus of contracts. This is contrasted with
Coase's theorem of a hierarchical model of corporations.
Class Notes

If you look at corporations as a nexus of contracts view vs. Coase series of hierarchical relationships. If nexus
of contracts view law is more subject to contractual negotiation so many issues can be contracted away, but
there always remains a baseline. In actuality a combination of the two theories so not all governance laws can
be replaced by contract.

Theory of promoting developing corporate norms has been waning. Separation of powers notion in corporate
structure.

V. Corporate Structure

A. Shareholdership in Publicly Held Corporations

Text Outline

In early corporate history the dispersion of corporate shareholdings prevented severe collective action problems,
allowing for ownership but not control. Institutional investing has shifted ownership to a more centralized group
of shareholders with a greater say and more incentive to voice displeasure rather then walk. Institutional
shareholders fall into six basic categories; (1) Private pension Funds, (2) Public Pension Funds, (3) Banks, (4)
Investment Companies, (5) Insurance Companies, (6) Foundations. Institutional investors now hold about 50%
of equities. The concentration increases sophistication has increased giving a greater and more sophisticated
"voice" in the companies, and allowing for easier and cheaper coordination between shareholders. There is a
free-rider problem in that any expense an institutional investor incurs for beyond the ordinary course
shareholder activities will benefit the other shareholders more then itself.

The forms that institutional involvement in governance may take are; (1) voting on management and
shareholder proposals, (2) making shareholder proposals, (3) election of directors to represent institutional
investors, (4) consultation with management.
Class Notes

Big structure question is what is the reality vs. statutes, is ownership and control in hands of shareholders,
professional institutional shareholders, or general shareholders. What is the influence of index strategy and
institutional investment on the shareholder/manager relationship? Indexing and institutional ownership make it
harder to unload the stock giving managers more incentive to influence companies.

Berle & Mean's Thesis: Bottom line is that corporation is not controlled by the shareholder. There is "agency
costs" involved in monitoring management, collective action problems in coordinating actions so selling stock
main recourse. Proxy vote issue, management votes proxy of unvoted shares. Do institutional shareholders
change this calculus. ERISA placed fiduciary duties on institutional shareholders. Walking away from stocks is
much harder for the institutional shareholders. Indexing strategies also make it harder to walk away.
Consultation with big shareholders prior to decisions becoming more common.

31
Delaware has no nonshareholder constituency statute, but about 30 states do.

B. Allocation of Legal Power Between Management and Shareholders

Text Outline

Thesis is that powers granted to management, whether by statute or charter are necessary and at all times
exercisable only for the benefit of the shareholders as their interests appear. The use of the power is subject to
equitable limitations when the power has been exercised to the detriment of their interests, however technically
correct the exercise has been.

As a general rule stockholders can not act in relation to the ordinary business of the corporation nor control the
directors in the exercise of the judgment vested in them by virtue of their offices. Shareholders can remove a
director for cause, even in the absence of a statute that so provides. In the absence of statute, the board cannot
remove a director, with or without cause. Cases are split on whether a court can remove directors for cause.

The Business Judgment Rule: Corporate law employs a number of different standards of judicial review, the
most lenient is the business judgment rule. Under this rule, if certain conditions are satisfied an officer will not
be held liable for consequences of a decision unless the decision was irrational. In Blasius the court with regard
to interfering with shareholder voting applied the more stringent rule of compelling justification.

Weighted Voting in Publicly Traded Corporations

In majority of companies only common stock has voting rights, but they can be conferred on preferred stock or
even bonds. There can also be two classes of stock, one with super-voting rights, a structure that can be used in
anti-takeover defenses.

Blasius analysis looks at whether there was intent and opportunity to vote, not the substantive outcome.

Del. Art § 109 vs. § 141: Statute in 141 allows limitations otherwise provided for in this chapter, does this
include 109? Can't determine and is a huge policy issue, seems to imply management wins. Allen argues Del
would vote that management would be allowed to include pill provisions in its by-laws unless they totally
disenfranchise shareholders. Blasius did not fundamentally decide this issue.
Class Notes

FL & Del. statutes are designed to help out smaller corporations that are most like partnerships, close
corporations. How does annual director vote mesh with state shareholder statutes when directors are wished to
be removed prior to vote? Note pg. 169, can charter remove right to remove directors for cause? Cases say that
charters cannot take away the right for removal for cause. Some technical problems with shareholder removal in
that you do not have a right to call a special shareholder meeting without approval of director.

FL Director Removal Statute: Abstract: 607.0808 Removal of directors by shareholders. (1) The
shareholders may remove one or more directors with or without cause unless the articles of incorporation
provide that directors may be removed only for cause. (3) If cumulative voting is authorized, a director may not
be removed if the number of votes sufficient to elect the director under cumulative voting is voted against his or
her removal.

Differs from Del. removal rights. Delaware only allows removal with cause, so FL has the easier removal
statute. Most courts do not consider bad business judgment adequate for removal for cause. In Del. gross
negligence is the standard. If charter gives removal rights to other directors rather then shareholders does not
infringe on right of shareholder. Removal right for cause, need to show cause and provide due process, leads to
procedural and substantive problems with removal especially without cause. Management often controls the
32
proxy process.

Shareholder meetings, most statutes allow for meeting for which shareholders can sue for if not held. Not
regulated what needs to be completed at the meeting. Fed proxy rules only require compliance with 12G
corporations, not all corporations. Special meetings need to give notice and agenda.

3 types of shareholders have right to call special meeting in addition to directors: Those with greater then 10%,
those given right in the charter, directors. Needs to be provided for by state law, Delaware does not give that
right. Conflict between models of shareholder primacy and director primacy. Virtually all jurisdictions allow
unanimous written consent to conduct business in place of meeting, Del. allows less then unanimous consent
but majority vote.

Change of Control Situation

Ch 12 Corporate Combinations pg 1061 starts, M&A takeovers not assigned read on side.
Primer: Two innovations made takeovers viable, hostile tender offers, and new forms of financing such as junk
bonds LBO. Just the threat affected management's operations.

Some takeovers require approval of board of directors. Statutory, Mergers and Sales of Assets. Non-statutory,
share purchases, tender offers proxy contests-happen without consent of directors.

Mergers § 11 RMBCA, the combination of two entities, in some jurisdictions super-majority is required to
consummate a merger. In asset sales management has complete discretion unless the assets are the substantial
majority of the business. RMBCA jurisdiction significant asset sales only require majority of those shareholders
voting. Shareholders cannot initiate merger discussions, only directors, who do not release for vote and
negotiate the deal giving to shareholders for up or down vote.

If corporation "B" rejects friendly offer, corporation "A" has the option of going to non-statutory measures. Can
have a proxy contest, vote in directors friendly to the merger, then consummate the merger. In tender offers,
board of Corp. "A" makes public offer to buy shares of company at X price upon certain terms. Acquirer needs
a minimum of 51% in order to gain control or deal is not attractive. If to many shares are tendered, they will be
accepted in a pro rata share then kick back to shareholders unneeded balance, must give shareholders equal
opportunity. Institutional investors always prefer tender offers as guarantees a premium in share price, avoids
SEC disclosure requirements and possible leaks involved with private deals or buying on the market.

Jury still out whether mergers are bad or good, arguable on both sides. Corp. A will want absolute control and
freeze out balance of shareholders in B on the back-end giving them a lower price, effectively threatening
shareholders into accepting tender. Need to look at fortunes of target and acquiring shareholders and societal
impact to determine if hostile takeovers are a good or bad thing.

Ways to fend off takeover, both how to use the by-laws, how to make expensive share oriented methods, Lipton
& Flohm preeminent lawyers in this field. Underlying question is whether you view these tactics as good or
bad. Good argument is that if you leave your company unprotected the "sharks" will take over as cheaply as
possible, need to delay in order to allow for a stronger negotiation position. Bad argument is that management is
just protecting their jobs and trying to retain control, should just let the shareholders decide if it is a good deal or
bad.

Tactics for takeover fend off: (1) Staggered Boards- Boards that only elect 1/3 of the board every year. Guise is
that you can't have a new board every year that does not know the business, protects by delaying takeover. (2)
Super-majority requirements- Requires something like 80% shareholder approval to implement merger, can
structure to come into effect after acquiring company has purchased a certain % of shares, Del § 102(b)(4), (3)
Crown Jewel Defenses- Options for sale of key parts of the organization to other entities, (4) Self Tender- By
33
back stock in company tender offer, (5) Debt Increase- Higher leverage makes for a less desirable target, (6)
White Knight- Seek out a friendly company for friendly merger or stock block purchase, (7) Poison Pill-
Numerous in number and sophistication, designed to make takeover difficult upon triggering event. Often
existing shareholders will get opportunity to purchase large block of shares at a discount to make purchase
highly expensive.

One position is that these poison pills just entrench management and go against boards fiduciary duty, flip side
is that they can be good for current shareholders by protecting company from offensive tactics of sharks. Del.
court has taken a somewhat middle ground. Comes down to who decides how the process of acquisition will be
taken.

Directors have a duty of care to the shareholder, but the standard by which to measure that duty is deferential to
the court. Courts have used standard of ordinary business judgment and given management much leeway, but
when given a self-dealing transaction courts have viewed with a much tougher standard. Antitakeover measures
can be both self-dealing to protect management and in the best interest of shareholders, thus Delaware applies
the Unocal higher scrutiny standard. Two prongs; (1) is there a realistic threat to the company, and (2) is the
response proportional and reasonable.

Some of the tactics have influenced shareholder votes directly. Delaware case string seems to comes down
that courts will not tolerate interference with shareholder voting.

Pull case, Quickturn Design v Shapiro, 1998 WL 954752 (1998). Dead-hand, no-hand and slow-hand
provisions have been found invalid and unenforceable by the courts as they prevent a current board from
exercising its duties.

Can you solve the § 109 v § 141 problem? Resolved in MM v liquid Audio expanding Blasius. Is board power to
repeal shareholder approved by-laws a large threat? Not likely as shareholders will be pissed and vote out
board, and there is some empirical evidence that it increases bids in buy-outs. Have to expressly say in by-law
that can not be repealed, or be statutorily provided as in FL, then no problem.

Charlestown Boot & Shoe Co. v. Dunsmore

FACTS: Osgood was chosen by the corporation to wind up the company. Defendants refused to act with him
and contracted additional debts leading to a accrued loss of $3,300.40. Also, defendant was charged with paying
the insurance which he did not and the shop was consumed by fire.
ISSUE: Whether the directors were negligent in their fiduciary duties.
RULE: Court finds the vote choosing Osgood a committee to act to be void, and that they had no legal duty to
pay the insurance.
NOTES: Election is void. Shareholders need to leave stewardship in hands of directors. Since corporations are
viewed as entity theory directors are viewed as agents of corporation rather then agents specifically of
shareholders. As agents of the corporation, directors have the fiduciary duty to the corporation.

Schnell v. Chris-Craft Industries, Inc.

FACTS: A petition for injunctive relief was filed to prevent management from advancing the date of the annual
stockholder meeting. Lower court rejected management's business reasons as being disingenuous and designed
to cut down the time available for plaintiff's to wage a proxy battle.
ISSUE: Whether legally complying with the Del. statute allowing management to change the annual meeting
date is permissible.
RULE: Court finds that even though technically within the Del. law, there are inequitable reasons to move the
meeting based on desire to hamper a take-over bid so original annual meeting date is to be reinstated.
NOTES: Judge agrees that maneuver was in bad faith by using voting mechanism to entrench themselves.
Single purpose has to be so shareholders do not get to vote.
34
Blasius Industries, Inc. v. Atlas Corp.
FACTS: Dispute between Atlas Corp. and largest shareholder, Blasius, over who will sit on the board. Blasius
acquired 9% of the stock of Atlas with the intent to restructure. Atlas had just completed a restructuring and
sought to prevent the takeover. Atlas called an emergency meeting where that elected two now board members
in staggered terms, preventing Blasius from obtaining a majority of board seats. Court finds the move was not
ordinary management of the firm, but an attempt to block the shareholders from voting on Blasius' proposal.
Defendants dispute this claim stating that the move was allowable under the plan and not a conflict of fiduciary
duties.
ISSUE: Whether under the circumstances the board, even acting in good faith, may validly act for the principal
purpose preventing the shareholders from electing a majority of new directors, an issue not of intentional wrong
but of authority.
RULE: Court finds an unintended breach of duty of good faith by the board in that they could have taken more
appropriate measures to fend off proposal. Holds that the decision of board make-up should be left to the
shareholders and not the board itself.
NOTES: Court does not adopt a per sea rule, but puts a very high standard for the board to meet at their burden.
Judge Allen alludes that a coercive attempt by a shark in short time to respond could be found acceptable.
Blasius is a hard case for whose holding to apply, but isn't it a courts job to sift through circumstantial evidence.
Delaware Ct. basically said this is a high hurdle, has not expanded at all.

Stroud v Grace
FACTS: Strouds allege that board breached its fiduciary duty by recommending certain charter amendments to
shareholders, along with contesting the accuracy of those disclosures. Measures changed the procedure for
nominating board members.
ISSUE: Whether amendments in a non-takeover situation granting additional power and effectively freezing the
board is legal.
RULE: Court found no breach of fiduciary duty to minority shareholders, examining the amendments under an
"intrinsic fairness" test.
NOTES: Procedures to ding the nominee at the nomination meeting. Court is not going to micromanage,
majority shareholder vote is sufficient. Essentially saying that if you being a "as applied" challenge we will
consider it. Courts took view not to expand shareholder rights and not expand Blasius. Court says don't look at
us to change the substantive outcome of the vote, as long as you were provided a fair opportunity to vote.

Williams v Geier
FACTS: Cincinnati Milacron adopted a recapitalization plan. In the plan holders of common stock on the
record date would have ten votes per share. Plaintiffs argued that the recapitalization unfairly benefited the
majority block and its intention was to entrench management.
ISSUE: Whether to apply the Blasius compelling justification standard when shareholders are not given a full
and fair opportunity to vote.
RULE: Only demonstrating that the board breached its fiduciary duties may the presumption of the business
judgment rule be rebutted, shifting the burden to the board. The boards action is thus protected by the business
judgment rule. Court also finds that the presence of a controlling majority stockholder did not undermine the
validity of the vote.
NOTES: Existing shareholders got 10 shares, new shareholders received only 1 in recapitalization plan. Was a
hobson's choice as there was a fear of delisting from the NY exchange if passed by less then 66%. Court does
not go behind case viewing as best option for corp. Can't do dual class recapitalization under the rules of the
exchanges today. Court basically comes down that economic interests can win over minority shareholder
disenfranchisement.

Teamsters v Fleming Companies

35
FACTS: Teamsters proposed to remove a shareholder rights (poison pill) plan through resolution, and
implement requirement for shareholder vote on such plan. Board wanted to approve by-law changes that
adopted this poison pill.
ISSUE: Does OK Law restrict the authority and implement shareholder rights plans exclusively to the board,
and may shareholders propose resolutions requiring that shareholder rights plans be submitted to shareholders
for vote at the annual meeting.
RULE: Court holds that there is no exclusive authority granted to the board, and no law precluding
shareholders from proposing resolutions or by-law amendments. Shareholders may restrict the board of
directors authority to implement shareholder rights plans.
NOTES: Started in Fed Ct. as Teamsters took advantage of SEC rule allowing shareholders to include
amendments for vote. Pill is essentially a stock option plan and court says shareholders have right to vote on
stock plans. Stock option analogy used by courts does not back up this argument well. Shareholders have
review authority, and binding proposal can be adopted through proxy. What is day-to-day operations of the
company which are excluded from Fed proxy law will be determined by the sate. Presumption that shareholders
can vote through by-laws, but can be contracted away. RMBCA jurisdictions allow board to adopt by-laws, but
shareholders can propose non-repealable by-laws. In Del. each side can adopt/repeal allowing for circular
battles. Court is also influenced by previous vote by majority of shareholders to redeem pill which was not fully
implemented.

General Datacomm Industries, Inc. v. Wisconsin Investment Board

FACTS: General Datacomm (GD) seeks declaratory and injunctive relief regarding the validity of a by-law
proposed for consideration at GD's annual meeting by shareholder. By-law sought to prevent repricing of any
stock option issued, i.e. used as a poison pill.
NOTES: Footnote 1 & 2 are keys to this case. Device can be used either to make money, or to hoard shares at
a low price in order to fend off takeover. Classic conflict of § 109 vs. § 141. Court focusing on the "what" that
was done not the "who" that did it. If it can be repealed at any time is it the same as a slow hand provision? GD
Court says they are not going to answer the question whether shareholder rights can be constrained, Quickturn
says that you can't, but can the shareholder provision in GD really be repealed? Two cases in Del. Ct., centaur
and American Rent a Car, which go opposite directions while GD court ducks the question. § 109 Del. governs.
Provision is in certificate of incorporation, but it can be repealed at any time, so is it a shareholder right?
Quickturn says repeal by board is ok. Can look at Unocal analysis that if response is relative poison pill can be
ok.

Hilton Hotels Corp v ITT Corp

FACTS: Hilton announced tender offer for ITT which they rejected. When it became clear ITT was not going to
hold their annual meeting Hilton filed for injunction to force them. ITT adopted a staggered board and poison
pill.
ISSUE: Whether a targeted company in the face of a hostile takeover can adopt protective measures to stifle the
takeover.
RULE: When an acquirer launches both a proxy fight and tender offer, it invokes both Unocal & Blasius tests.
These cases have a distinction in two types of corporate power; (1) Power over the assets of the corporation
(Unocal), and (2) power relationship between the board and shareholders (Blasius).
NOTES: ITT #1, not in supp.: Board adopts a series of anti-takeover measures in order to prevent hostile
takeover by Hilton. NV Ct. says that according to state law you can sue after 18 months, annual meeting means
18 months in NV. Doing it to screw Hilton and court says ok, runs opposite of Schnell. In ITT #2, supp., Ct.
uses Blasius here in finding that board is interfering with shareholder voting, finding primary purpose is to
entrench, through circumstantial evidence. Court looks at Unocal, looking to see if there was a threat and a
reasonable response, but says there was no threat here. Court may have found that in cases where board thinks
there is a threat, and implements a plan, it must bring that plan to the shareholders.

MM Companies v Liquid Audio

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FACTS: MM sought injunction against Liquid Audio from expanding their board from 5 to 7 members.
NOTES: Poison pill in place, MM needs to get board control to get power. No special meeting provided for in
by-laws, MM waits until annual meeting. Advance notice provision in by-laws requires 60 day notice to include
important provisions in annual meeting, MM complies. MM introduces a board-packing provision, Liquid finds
a white knight. Can they put deal protection devices into white knight arrangement, such as we will pay you
$XX Million if the deal does not go through. Also no-shop and lock-up provisions have been found ok by courts
(not here). Because of Alliance merger (white knight) liquid postponed meeting, court did allow it to delay
some. Liquid also lowers stock ownership trigger for pill, and increases the number of board seats so they can
pack it. Shareholders voted in new MM directors, but packing scheme allowed Liquid to still retain control.
Court basically says no problem, you got your vote, we're just guaranteeing shareholder franchise not a win.
Del. supreme court reverses, finding this case the perfect opportunity to use Blasius within Unocal,
Blasius as the second prong. Page 33 analysis key to the case, leaves us not knowing how far ruling goes.
If effects shareholder vote, need to apply Blasius. How exactly is this step taken to thwart effective
implementation of shareholder franchise? Seems to expand Blasius when it had previously been limited.

C. Legal Structure of Management

Text Outline

The Traditional Legal Model

Under the traditional corporate legal model, the board of directors manages the corporations business, and the
board is conceived as an independent institution, not an agent of the shareholders. Shareholders have no legal
power to give binding instructions to the board on matters within the board's exclusive power, and directors are
normally removable by shareholders only for good cause.

Modern Corporate Practice

Management function is ordinarily located not in the board, but in the executives, and the central figure is the
CEO.

Constraints of Time
Boards of publicly held corporations meet an average of 8 times a year. By reason of time constraints alone the
typical board could not possibly manage the business of a large publicly held corporation.

Constraints of Information
Officers typically not only have much more information then the board, but control much of the flow of
information to the board. By controlling the information officers heavily shape the decisions that the board
makes.

Constraints of Composition
The typical board includes a number of directors who are economically or psychologically tied the
corporation's executives, particularly the CEO. Indeed, a number of seats are usually held by inside directors,
i.e. the corporations executives. These executives are unlikely to dissent at a board meeting.

The Monitoring Board

The monitoring model of the board recognizes that in a publicly held corporation the management function is
exercised not by the board but by the senior executives. Under this structure, the primary function of the board
is not to manage the business but to select, regularly evaluate, fix the compensation of, and where appropriate
replace the senior executives and monitor the corporation's business to evaluate whether it is being properly
managed.
Class Notes

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Attempts to regulate boards, legislatively Sarbanes-Oxley. S-O requires disclosures, certifications of accuracy
and truth, protects whistle blowers and stiffens penalties. S-O on page 1964 in statute book. Nominating
committees for directors rather then appointments are recommended but not required. Compensation committee
requirements and independent audit committees are also addressed. IRRC shareholder monitoring organization.

Proposed and implemented SEC and NYSE rules have also had a constraining effect. Independent board rating
agencies and executive search firms are also having a monitoring effect. Still have problem with defining what
are director responsibilities and duties. Complaints on one side are that its hard to get qualified board members
given the legal liabilities, on the other are complaints that SEC and other disclosure requirements are not
enough.

Staggered boards and classified boards need to be approved in charter, otherwise annual voting.

D. Formalities Required for Action by the Board

Text Outline

Formalities required for action by the board, the governing rules include; (1) meetings, (2) notice, (3) Quorum,
(4) voting.
Consequences of noncompliance include; (1) unanimous explicit, but informal, approval, (2)explicit majority
approval coupled with acquiescence by remaining directors, and (3) majority approval or acquiescence.

It is fair to say modern courts would hold that at least in the context of a closely held corporation, explicit but
informal approval by all the directors is effective where a person who has contracted with a corporate officer
has been led to regard his transaction with the corporation as valid and all the shareholders are either directors
or have acquiesced in the transaction.
Class Notes

Minutes of board meeting are discoverable, so often little detail and used strategically. Quorum is majority of
the full board, no quorum then activity taken is invalid. Majority of those present not just voting are required,
abstentions become negative votes.

E. Authority of Corporate Officers

Text Outline

President: the prevalent modern rule is that the president has apparent authority to bind his company to
contracts in the usual and regular course of business, but not to contracts of an "extraordinary" nature. The
difficulty lies in defining what is ordinary vs. extraordinary, but some boundaries can be identified. Some
matters, such as declaration of dividends, are required by statute to be decided by the board. Statutes also
enumerate what matters the board cannot delegate to a committee. Additional elements to determine what is
extraordinary is the economic magnitude of the action, risk and time-span of the action. The Presidents actual
authority may be greater then his apparent authority.

Chairman of the Board: There is little case law on the apparent authority of the chairman because the actual
authority can vary greatly. The definition of chairman and CEO is very gray, but in many companies the
chairman retains the title while handing over day-to-day operations to a successor, other times held by a retired
CEO still valued, and others used to split tasks between two equals.

Vice-Presidents: Vice presidents are usually given little or no apparent authority at the corporate level.

38
Secretary: Secretary has apparent authority to certify records of the corporation including resolutions.

Courts will often view closely held corporations, and their executives, as having the same powers as possessed
by partners.
Class Notes

Authority issue comes up when one of the parties wishes to get out of a deal.

F. Formalities Required for Shareholder Action

Text Outline

Notice of place, time and date is required for the annual meeting of shareholders and for any special meeting.
Notice of special meeting must include the reason for being called. Only persons who are record holders on the
record date are entitled to vote at the meetings. Under most statutes a majority of the shares entitled to vote is
necessary for a quorum unless overridden by certificate of incorporation. Fundamental changes such as sale,
merger, dissolution and amendments to the amendments usually requires two-thirds votes. Election o directors
requires only a plurality.
Class Notes

How can you tell which shareholders are entitled to vote at the meeting? When millions of shares traded daily
not easy to determine whose the owner on the record date. Deposit trust company will hold shares and have
record of the holders. Default you need to look at the certificate of incorporation.

G. Cumulative Voting
Text Outline

If someone owns 100 shares and 7 directors are running, under straight voting they can cast 700 votes total but a
max of 100 per candidate. Under cumulative voting a shareholder can cast up to the 700 votes, split among the
candidates any way they wish. Under straight voting a minority can never elect a director over the objection of
the majority, while cumulative voting can.
Class Notes

Really just an issue if were going to make it easy or hard to allow minority representation. Idea is that you do
not vote one-by-one but vote for all seats at the same time. Can pool your votes so that a minority shareholder
can be guaranteed at least some board representation. Deployment can be tricky and minority shareholders have
actually gained more seats then the majority using cumulative voting wisely. Cumulative voting became
mandatory in some states, but since rolled back to a permissive theory.

Ways to thwart cumulative voting are staggered boards, having a fewer number of directors. Permitting
vacancies to be filled by the board, then force minority voters to expend their shares voting out this person.
Argument for cumulative voting is that additional points of view and perspectives can be heard on the board,
argument against is that can be used as "spies", lead to partisanship etc. Current proponents of cumulative
voting still feel they should be permissive as it stands now.

H. Limited Liability
Text Outline

Shareholders have no liability for corporate obligations, even though commonly called "limited liability."
39
Limited liability has nothing to do with being a separate entity, as RUPA confers liability on partnerships even
though a separate entity, but is statutorily granted. This protection applies to corporate managers as well as
shareholders, shareholders by statute and managers by agency principal.

It is generally known that shareholders of a corporation have limited liability, but this can be contracted around
by requiring personal guarantees, can have covenants required to meet certain financial thresholds, or can
charge a price that reflects the extra risk. One argument (stupid one) is that shareholders should have personal
liability as corporations are encouraged to take to much risk. One counter is that limited tort liability improves
the efficiency of the market. Proposal has been that shareholders be liable on a pro-rata basis rather then a joint
and several basis.

Inadequate capitalization is merely a factor considering whether or not to pierce the corporate veil. Although
tests for piercing the corporate veil are similar from state to state, the application can vary greatly. Wash. DC
concludes that not keeping up formalities can be prima facie evidence to pierce, while VA requires common law
fraud.
Class Notes

Basic assumption of being a shareholder is that you have limited liability. Whose pocket do you go into when
you pierce the corporate veil and does it matter if it's tort or contract liability? Very little doctrine in this area.
Organizing by issue makes more sense then by doctrine.

Arguments in support of limited liability; encourages investment, encourages management to be less risk
averse, improves efficiency of markets and is a more transparent legal structure then partnerships. Cons are
taxes and can be used to avoid liabilities.

Argument: Basis- Financial Risk already a factor, Tort risk not an issue, i.e. money grab solution to no
problem
Market Efficiency - Global Markets, reduced trading,
Undermine incentive to incorporate
Innocent players get punished, retirement funds and unknowing

Under Del. law not enough to just show "alter ego" to pierce the veil, but also need to show fraud. Commingling
of funds an issue such as in Sea Land where CEO is using corporate bank accounts as his own. Should
fraudulent conveyance law be the basis for piercing the corporate veil vs. a combination with under-
capitalization. Other theories are piercing only corporate parents.

Piercing the Veil Review: Need to start by thinking about the issues, mainly the fundamental corporate fact of
limited liability and is there a rationale for piercing. Finding the balance between fairness to creditors and
corporate doctrine. Is there something different about parent/subsidiary structures that should allow for easier
piercing? Is there something about torts that allows for easier piercing. Should piercing be harder if the
investors are sophisticated? Is there a better alternative to piercing? Organize in this manner of answering these
questions.

Del. Doctrine, if just alter ego you cannot pierce without fraud, but why? Protection of closed corporations.
Also hard to pierce in FL, need improper purpose. In FL every case of piercing has either been a sham or corp.
used for fraudulent purposes. Parent sub corp. is same issue as brother sister corp. Courts generally do find it
easier to pierce the veil in parent/sub relationship. Courts moving away from Minton undercapitalization test,
but this is still what often bothers the court. Eisenberg feels piecing should be a given for torts, possibly pro-
rata, in actuality courts and the law is going the other way. Another issue is should you make a rule that reflects
sophisticated parties or that protects the little guy like in Kinney. Another view is not to consider bargaining
40
power but look to see if there have been misrepresentations that ensure that one party does not have enough
information. Fraudulent conveyance (now UFTA) is old doctrine saying that creditors should not be able to use
sham corporations to defraud, does not necessarily need to be intentional fraud, but has administerability and
proof problems. Very little piercing in public corp. context, usually of closed corporation. Director signs person
guarantee, they pay not because of any doctrine but because of the guarantee given, i.e. direct liability. Similar
when director commits a tort in their duties as director.

US v Best Foods: Basically they were completely running the company so held liable.

Fletcher v. Atex, Inc.

FACTS: Plaintiffs filed suit against Atex and Kodak to recover for repetitive stress injuries they claim were
caused by Atex's keyboards. Kodak was granted summary judgment, plaintiff's appealed alleging Kodak acted
tortuously in manufacturing and marketing the allegedly defective keyboards. As Atex is a Del corp. Del. law
decides when the corporate veil can be pierced.
ISSUE: Whether Atex in fact operates as an entity with Kodak rather then a subsidiary thus allowing for
vicarious liability.
RULE: To prevail on an alter ego claim under Del. law a plaintiff must show (1) that the parent and subsidiary
operated as a single economic entity, and (2) that an overall element of injustice or unfairness is present. It is
undisputed Kodak followed corporate formalities here.
NOTES: View is that as long as subsidiary is acting as a separate entity it will be given the benefit of separate
corporate liability protection. Delaware court not eager to pierce the corporate veil.

Walkovszky v. Carlton
FACTS: Plaintiff was injured by a cab, industry practice is for a corporation to own one or two cabs only.
Owner of defendant cab company is stockholder in 10 others, plaintiff claims all are operated as a single entity.
ISSUE: Whether defendant's corporations should be considered one single entity for liability purposes.
RULE: Plaintiff gave no rational to support agency theory of corporation.
NOTES: Not a case of holding corp., but of multiple corps. owned by the same shareholder. Would need to
show fraud or some event leading to personal liability, not liability of a holding corp. If making an agency
claim, could only get into the pockets of the individual corporations, to get into the pocket of the shareholders
need to show "alter ego" or fraud, commingling etc. based on the shareholders actions. Argument in dissent is
that regardless of what the legislature says the under-capitalization is sufficient to pierce the veil. Two
contrasting views.

Minton v. Cavaney
FACTS: Plaintiffs daughter drown in a public swimming pool recovering a $10K wrongful death judgment
from Seminole Pool. Plaintiffs brought second action trying to hold defendant Cavaney personally liable for this
judgment. Seminole corporation had no assets and never functioned like a corporation.
ISSUE: Whether Cavaney, as director and officer, can be held personally liable for the judgment against
Seminole.
RULE: As Chaney was not party to the original suit he cannot be held personally liable as he did not defend
himself.

Sea-Land Services, Inc. v. Pepper Source

FACTS: Sea-land shipped peppers on behalf of Pepper Source, which did not pay the freight bill. Sea-Land
obtained judgment but Pepper Source had dissolved. Sea-land seeks to hold Marchese personally liable, then
pierce his corporations veils.
ISSUE: Whether Marchese's corporations are an alter ego and fraud or injustice occurred.
RULE: Courts finds that the corporations are alter ego's, but the prong of injustice is not well defined and needs
to be shown by Sea-Land.
NOTES: Why do you not have a piercing here when he has commingled funds so much? Commingling not
41
enough, in the end he is found liable for not paying taxes on these proceeds. Even uses completely different
third party as basis for unjust enrichment, not just harm against creditor. Court applies Van Dorn test: (1)failure
to maintain adequate corporate records or to comply with corporate formalities, (2) the commingling of funds or
assets, (3) undercapitalization, and (4) one corporation treating the assets of another as its own. On appeal from
remand court finds Marchese liable for $118K in damages and that second prong was satisfied and Marchese
unjustly enriched.

Kinney Shoe v Polan

FACTS: Kinney sued Polan the owner of Industrial Realty who they invested in yet had no assets or formalities
as a corporation.
RULE: Polan found liable as he did not even try to keep up corporate formalities in order to take advantage of
limited liability.
NOTES: Given how sophisticated the creditors were should the veil have been pierced? Sophisticated
contracting parties should know enough to get guarantees etc. Is it possible that Polan lied to make it impossible
for Kinney to contract fairly. Strange that company goes belly up only two moths after lease is signed.

I. Equitable Subordination of Shareholder Claims

Text Outline

Under the doctrine of Equitable Subordination, when a corporation is in bankruptcy the claim of a controlling
shareholder may be subordinated to the claim of others, including the claim of preferred shareholders, on
various equitable grounds. Equitable subordination simply takes an investment already made, and denies it the
status of a creditors claim on parity with outside creditors for controlling behavior by the parent corp.
Undercapitalization plays an important role as it does in piercing doctrine. If a parent and a subsidiary are both
bankrupt, the court sometimes consolidates the assets and liabilities of the several corporations into a common
pool.

Benjamin v Diamond: Three conditions must be satisfied before exercise of the power of equitable
subordination is appropriate; (1) the claimant must have engaged in some type of inequitable conduct, (2) the
misconduct must have resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the
claimant, and (3) equitable subordination of the claim must not be inconsistent with provisions of the
bankruptcy act.
Class Notes

Equitable Subordination happens in the bankruptcy context, usually happens when partners are in bad shape,
they incorporate, transfer funds into corporate loans to themselves from the corporation then declare
bankruptcy. Courts will not buy the scheme.

J. The Corporate Entity and the Interpretation of Statutes and Contracts

Text Outline

This is the question where when corporations are prohibited from an activity, will individual shareholders be
prohibited from the activity as well. DHL ownership and control scenario.

VI. Shareholder Informational Rights and Proxy Voting

A. Shareholder Informational Rights Under State Law

Text Outline

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Most legislatures have enacted statutes governing the right of inspection, with many being more limited in
coverage then the common law rule of a shareholder "acting in good faith for the purpose of advancing the
interests of the corporation and protecting his own interest as a stockholder."

Proper Purpose: Courts have found proper inspection to determine the financial condition of a corporation and
to ascertain the value of the petitioner's shares. If the shareholder has a proper purpose, but also a secondary
purpose, any ulterior purpose is irrelevant. Pillsbury case.

Stockholder Lists: Courts stand readier to grant access to stockholder lists then to grant access to otherwise
confidential financial and business information. Owners of record may be different from beneficial owners.

The SEC Act which is applicable to corporations of at least 500 record holders requires corporations to report
certain information to all shareholders without specific shareholder requests. To capture the smaller
corporations the RMBCA § 16.20 requires that every corp. must furnish shareholders annual financial
statements including balance sheets and income statements.
Class Notes

You can get by right corp. minutes and by-laws, but if challenging management you would also wish to get a list
of shareholders and certain internal management documents to show your case. In FL used to be limitations on
number of shares needed to request documents, now changed to which documents you wish to request. Under §
220 Del. defines what reasons and what documents may be provided. Need to show a proper purpose in acting
in your shareholder duties, shareholder has the burden of showing need. Del. makes big distinction to access to
books vs. access to shareholder lists, hard to get access to books. Need to show proper purpose to get access to
substantive information. FL statute is § 607.1602.

Del. Ct. says if shareholder has proper primary purpose to request the document, but improper secondary
purpose, court says it does not matter. Court takes a liberal view on what is a proper purpose, but narrow view
on what documents can be obtained.

Shareholder Inspection Rights

Pillsbury v Honeywell key case. Anti-war environment against Honeywell's munitions manufacturing, Pillsbury
attempted to purchase shares in order to solicit Honeywell shareholders about anti-war views. Court says no as
the purpose needs to be economic. Two arguments here, Delaware Court vs. Honeywell court.

Security First v US Die Casting and Development

FACTS: Defendant is a publicly traded bank while Plaintiff is a closely held corporation holding 5% of the
banks stock. Bank entered into merger agreement with Mid Am, a larger regional bank holding company. Upon
failure of merger and payment of termination fee, Plaintiff demanded access to bank's books, was denied, sued
under Del. Stat. § 220 and won in lower court. Appeal by bank ensued.
ISSUE: Whether plaintiff showed by preponderance of the evidence a credible basis for wrongdoing.
RULE: That a stockholder may demonstrate a proper demand for the production of corporate books and records
upon showing, by the preponderance of the evidence, that there exists a credible basis to find probable corporate
wrongdoing. Court though limits the documents to be produced to those related specifically to the merger only
and available from the bank, not Mid Am.
NOTES: Plaintiff must show credible basis to find probable wrongdoing, and must justify each category of the
requested production.

Saito v McKesson HBOC, Inc.

FACTS: McKesson entered into a stock for stock merger agreement with HBOC, companies merged. The
43
merged company had to restate earnings down by $327.4M after audit, attributable to HBOC accounting
irregularities. Saito, a shareholder, sued under Del. § 200 for access to books and records to obtain information
to sue derivatively.
ISSUE: To what scope to allow access to documents for proper purpose investigation under Del. § 220.
RULE: Court rules that third party documents and those produced prior to Saito's stock purchase are
discoverable given they relate directly to the proper purpose, but as he was not a stockholder of pre-merger
HBOC those documents remain undiscoverable.
NOTES: Saito starts action in chancellery court to get access to documents as they are not sure of what they
will find at this point. Wants documents from time when he bought stock that are merger related, plus director
notes on merger, both from HBOC and McKesson. Court says you only have standing to documents since you
bought the stock, not before, and no HBOC documents as he was not a shareholder. Del. supreme court says
that documents prior are within the shareholder rights. Gets access to HBOC documents that McKesson got,
unredacted. Pg. 40, court uses piercing language, basically saying you can't engage in fishing expedition. Catch
22 in this language as they need to show likelihood of wrongdoing to obtain the documents which will show the
wrongdoing. Likelihood is a lower standard which can be obtained through documentary, testimony, logic, or
otherwise, i.e. restatement meets this criteria.

B. Shareholder Informational Rights Under Federal Law and Stock Exchange Rules
Class Notes

SEC disclosure requirements only apply to 12G corporations which require size and shareholder requirements.
FDR creates the securities act of 1933 with rules for issuance and disclosure. Forms 10K, form 10Q, and for 8K
required for special circumstances. Pursuant to Sarbanes-Oxly need to have annual disclosures and CEO & CFO
have to sign certifying that the documents are true. Have to sign at two levels, one as to the truth of the
financials and second as to the effectiveness of the audit and control procedures.

Also disclosure requirements by SRO's (self regulating organizations), such as the NYSE. If executives put
NYSE filing at risk they will sue for breach of fiduciary duties.

C. Proxy Rules: Overview

Text Outline

Proxy voting is the dominant mode of shareholder decision making in publicly held corporations. § 14(a) of the
Securities Exchange Act does not regulate private conduct itself, but authorizes the SEC to promulgate rules
that govern private conduct including proxy voting. The SEC has promulgated proxy rules that serve a variety
of purposes including:
Coverage: Rule 14a-2 provides that proxy rules apply to every solicitation of a proxy with respect to securities
registered pursuant to section 12 of the act. The language has been given a expansive interpretation.
Transactional Disclosure: One purpose of the proxy rules is to require full disclosure in connection with
transactions that shareholders are being asked to approve such as mergers, amendments and elections of
directors. Schedule 14A lists in detail the information that must be furnished when specified types of
transactions are to be acted upon by shareholders.
Periodic Disclosure: The proxy rules also require certain forms of annual disclosure.
Proxy Contests: Rule 14a-11 regulates proxy contests requiring the filing of certain information by insurgents.
Access to the body of shareholders: Rules 14a-7 & 8 provide mechanisms through which shareholders can
communicate with each other.
Mechanics of Proxy Voting: Another purpose of the proxy rules is to regulate the mechanics of the proxy voting
itself.
Class Notes

44
Notion that there was a need to have generally applicable federal law relating to content, misrepresentations etc.
§ 14 SEC act of 1934 says no-one can solicit proxies in contravention of SEC rules on the subject. Delegates a
large grant of power to the SEC to regulate securities matters. Pg 1843-82 in Statutes book outlines rule § 14(a)
(1) regulating proxies and what needs to be in the statements, focus is on § 14(a)(9) anti-fraud provisions.

Under § 12(g) companies covered are any traded on the exchanges, and non-traded companies of over $5M in
assets, leaving smaller companies not subject to § 14(a) rules.
D. Proxy Rules: Private Actions Under the Proxy Rules
Text Outline

In Borak the Supreme Ct. allowed that shareholders could bring private action for violation of the proxy rules
though neither the 1934 Act nor the proxy rules themselves explicitly provide for such an action.

Current law on materiality of proxy disclosures, Northway. An omitted fact is material if there is a substantial
likelihood that a reasonable shareholder would consider it important in deciding how to vote. It does not require
proof of substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to
change his vote.
Class Notes

Notes on Borak: Question is whether the court is going to say there is a private right of action, court answers
yes. Says private action is a necessary supplement to SEC enforcement. Scalia in Virginia Bankshares narrows
Borak but expressly chooses not to overturn it. Borak says let us put as many weapons into the hands of
shareholders, later narrowed to weapons limited by what congress say's as they could have provided if they
wished.

Question is now that private action is allowed, what are going to be the elements of fraud? § 14(a)(9) need to
have a material omission or a statement that is misleading. Need to go to common law fraud for
misrepresentation and material omission.

Notes on TSC Industries v Northway: Sup Ct. adjusts standard from a material fact that might have been
important to the shareholder but would have been considered important. Considers the might standard to low a
threshold that would lead to management fear of liability leading to deluge of frivolous information in proxy's.

Might want to know Would want to know Would change Vote

+--------------------------------------------------+-----------------------------------------------------+
Mills Std. TSC Standard Ct. Does not go here

Ct. says change vote to high a standard, Mills to low a standard. TSC looks at whether it was appropriate to
allow for private right of action, tip the Ct. will not be so generous to the private litigant. Intended restriction
of material in §14(a)(9). Mills not the law now, TSC is the law.

What is material? In Lyman case court says change of accountant to one that had been indicted not material as
location was in OK. In contrast, in Johnson Ct. finds immaterial that one of the directors had been campaigning
while being indicted for the foreign corrupt practices act. Shift to federalism, let them go to state court for
smaller issues. Also difference between transactional proxies and nominating proxies.

Shift from Mills to TSC making it a more difficult to apply standard, burden is more stringent in allowing
private right of action, policy of constraining private rights of action. Effectively makes the SEC the enforcer of
proxy and securities violations rather then private lawsuits.
45
Bankshares: Souter is basically looking for if there is a statement that was a material fact. If fact incorrect, but
directors opinion including the fact is believed correct, Plaintiff looses. Souter seems to say that there has to be
both belief of the directors and the truth arising from the actual situation. How to determine facts is on pg 303
middle, i.e. corporate records subject to documentation. If board says worth $60 and actually worth $42,
without additional evidence that shows board new it was worth $42 and lied are needed.

Neither TSC, Mills, or Bankshares answers the question if you need to show scienter? Adams states that scienter
should be an element of liability in private suits under proxy provisions as they apply to outside accountants,
but rule has not been picked up.

Problem in proving damages also, everything went to hell but how can you prove that it was due to the director
elected, deal approved due to misstatement?

Mills v Electric Auto-Lite

FACTS: Shareholder brought suit for injunction against voting on a merger but did not request temporary
restraining order. Filed an amended complaint to set aside the merger based on misleading statements in the
proxy. Proxy stated board recommendation for the merger, but did not reveal that board was already under
control of the acquiring company.
ISSUE: What causal relationship must be shown between a misleading proxy statement and the merger to
establish a cause of action based on violation of the Act.
RULE: Court holds that although misleading, it is not possible to undo the merger, so remanded to lower court
for a review on possible monetary damages if found that terms were unfair. Material defect did not need to be
decisive, only material.
NOTES: Case is defining what is a material omission? Need to prove causation. Plaintiff's likely did not seek
TRO due to need to post a bond. Seventh Cir. applies the standard that the misleading statement caused the
merger to go through, but-for cause i.e. torts. Hard to prove, so if the merger deal was fair would be unlikely
that it would be overturned. Can show causation, but not reliance on that causation given so many shareholders,
so they look at if a rational shareholder would have voted for the deal, i.e. was it a fair deal. Sup. Ct. says that
they will look at materiality or omission as prima facie evidence of materiality. Will look to see if it was the
kind of statement that shareholders would consider important, or might have changed the vote of the
shareholder. In a situation where proxy itself is an essential link in accomplishment of transaction, a material
misstatement can be a violation. FN7, not discussing what misstatement would be if proxy not material. Here in
Mills, proxy was necessary to transaction.

Virginia Bankshares, Inc. v. Sandberg

FACTS: First American Bankshares conducted a freeze-out merger eventually merging into Virginia
Bankshares.
ISSUE: Whether a statement couched in conclusory or qualitative terms purporting to explain directors reasons
for recommending certain corporate action can be materially misleading within the meaning of 14a-9.
RULE: Court holds that misstatements misled petitioners into believing that state remedies to upset the merger
had been lost, or that there was no loss of state remedy as minority shareholders did not have the votes to block
the merger as proxy was not required by law or by-laws.
NOTES: Courts here are imposing new Fed. rules on state regulators. First issue is what happens when
directors in a proxy puff-up the deal with conclusory statements under rule 14a-9. Attorney argues that opinion
is not a "material fact" as required by 14a-9. Squeeze out merger of Sandberg, minority shareholder, gets case
into Fed. Ct. as caps in VA judgments. Sandberg has an issue with the stock price as there had been a $60 sale
previous, this offer was for $42. Not necessary to go to shareholder vote, but did so to avoid claim of breach of
fiduciary duty. Plaintiff does not win because of causation problem, proxy was not a causal link. Ct. says that in
contrast to Mills, proxy was not necessary to accomplishment of the transaction, as Souter determines that the
merger could have been legally accomplished without the proxy despite management's pursuing that course.
46
Misleading statement was not material. Souter leaves an opening saying that if actions would cause a loss of
state law remedy, it may be possible to go to Fed. Ct., i.e. loss of appraisal rights. As here, will not trample state
laws that may allow for merger without proxy. Summary, when proxy is not essential to transaction, and there is
a big lie out there, you need to go to state court but if the door was closed because of that lie then you can come
to Fed. Ct. Scalia's position, go to state court. Kennedy's position is minority shareholders are exactly the group
intended to be protected as was in Mills. Can argue that Fed. violation is what caused you to loose state law
remedies. Palatable to right as opinion basically says you look at state law to determine remedy.

E. Proxy Rules: Shareholder Proposals

Text Outline

Rule 14a-8 provides that if management seeks to exclude a shareholder proposal from a proxy statement, it must
obtain a no-action letter from the SEC.
Class Notes

SEC § 14(a)(9) is key proxy provision, but § 14(a)(1) important. Proxy solicitations can be oral, or make
unilateral voting announcements in the newspaper.

Other two big litigated proxy rules are § 14(a)(7) & (8). (a)(7) shareholder can ask management for shareholder
list if wishing to offer a different board member. When management sends out the proxy they can send theirs
last which is binding, so will prefer to send themselves then release list. § 14(a)(7) differs from state law, but as
shareholder can always go to state law to get list. If making a shareholder proposal vs. board election, would
often be put into management's proxy materials under § 14(a)(8) shareholder proposal rule, this way
management pay's for solicitation for a social or other proposal that is likely to be unsuccessful. § 14(a)(8) does
not apply to board director voting. Rule is limited though as there are thresholds in ownership such as $2,000K,
exclusions under (i) etc. that limit who can submit a proposal and for what. 1998 Rule numbers changed. IRRC
Investor research firm web site.

§ 14(a)(8)(i)(5) Relevance is most important exclusion. Basically a tip of the hat by Feds. to state law saying
that shareholders must not raise provisions that are the normal operations of the business. In Cracker Barrel
court said that issue can be excluded as being in the context of employment issues which are ordinary course of
management's business. Later changed their minds back as ruling was to broad and reworded in § 14(a)
amendment, basically saying if there is widespread public debate on the issue it can't be excluded. Stock option
debate, if widespread program would be considered ordinary course of business, if narrowly drafted to top
management could be argued as social policy issue such a incentive to manipulate stock, disparity of pay. These
rationale can be used by the SEC to give itself leeway.

Pending rule § 14(a)(11) would say that given shareholders the right to propose their own board of directors for
nomination.

Roosevelt v. E.I. Du Pont de Nemours & Co.

FACTS: Lower court rules that shareholder proposal is relating to the conduct of ordinary business purposes,
affirmed.
ISSUE: Whether shareholders proposal is subject to exclusion under § 14(a)-8 of the SEC Act relating to
"ordinary business practices."
RULE: Court holds that a private right of action is properly implied from section 14(a) of the SEC Act.
Proposal for phase-out date and alternative CFC sources properly excluded under § 14a-8 as ordinary course of
business due to being existing production, not proposed new venture.

Amalgamated Clothing and Textile v Wal-Mart Stores

47
FACTS: Awarding of attorneys fees to shareholders in conjunction with a SEC 14a-8 ruling omitting
shareholder proposal.
RULE: Communication of a proposal relating to facilitate communications among shareholders and between
shareholders and management was found to be able to recover attorneys fees as benefit was to all shareholders.
NOTES: Shareholders still get attorney's fees.

F. Proxy Contests
Text Outline

Very few contested elections are run without the aid of professional proxy solicitors. The solicitor handles all
the physical requirements of the proxy campaign. The solicitor's database often allows for discovery of who the
beneficial owner of the stock is that will be voting. Solicitors also keep close contact with proxy clerks at
brokerage firms and appropriate bank officers to make sure that client's proxy material is being forwarded,
monitor voting results, and further persuade crucial voters. Solicitors also provide advance guidance as to
likelihood of a proxy passing, thus allow management to avoid failing proxies.
Class Notes

Traditionally not many proxy contests due to free-rider problem, expense and small likelihood of winning.
Easier to just sell shares. Changed when corp. raiders came into the picture conducting hostile takeovers. What
happened in the late 80's & 90's is management is working with major shareholders, helping to entrench
themselves. Is this still the case today? Does voting really provide a serious constraint on management?

Difference from agency law in that agent can not use partnership funds to support their positions while in
corporations the companies pay for the expense of proxy to elect themselves. Are these expenses justified and
when do they become entertainment.

Heineman: Not sure what rule is if directors pay themselves when they do not have shareholder approval.
Rosenfeld v. Fairchild Engine and Airplane Corp.
FACTS: Minority stockholder seeks to compel return of $261K paid out of the corporate treasury to reimburse
both sides in a proxy contest for their expenses.
ISSUE: Whether directors can reimburse proxy contest sponsors from the corporate treasury.
RULE: In a contest over policy, as compared to a purely personal power contest, corporate directors have the
right to make reasonable and proper expenditures, subject to the scrutiny of the courts when duly challenged,
from the corporate treasury for the purpose of persuading the stockholders of the correctness of their position
and soliciting their support for policies which the directors believe are in the best interests of the corporation.
NOTES: Judge uses Unocal hostile takeover standard and imports into proxy contest context. Court says not
appropriate to use corp. funds when purely a personal power struggle dispute, but can use when a dispute as to
policy. Dissent believes you need to look at the reasonableness of the amount spent as to the purpose.
Disagreement is when are the funds being used to persuade and when to inform. When new shareholders take
power they pay bills of both their and incumbents proxy contests, if they had lost they would have been left out
in the cold as pointed out by defense. Court says that shareholder approval was necessary to pay insurgents
proxy, not open to paying all insurgent proxies as that would encourage to many wasteful battles.

VII. The Duty of Care and the Duty to Act Lawfully

A. Duty of Care
Text Outline

48
Note on Causation
The court noted in Barnes v Andrews that not only does a plaintiff need to show a violation of duty of the
defendant, but that the situation would not have occurred if he had performed his duties.

Barnes v Andrews, J. Learned Hand, can be read for two propositions:

(a) That an inattentive director will not be liable for a loss that would have been prevented by an
attentive board unless it is shown that if the director had been attentive, his colleagues would have
followed his lead.
(b) Or more narrowly, that an inattentive director will not be liable for a corporate loss if full
attentiveness by all the directors would not have saved the situation, simply because in that case the
inattentiveness will not have been a cause-in-fact of the loss.

The ALI comes down where if the Board as a whole has violated it's duty of care either by omission or
commission, each director will be liable for any loss of which the boards failure is the cause-in-fact and
proximate cause. ALI § 7.18(b) A violation of a standard of conduct is the legal cause of loss if the plaintiff
proves that (i) satisfaction of the applicable standard would have been a substantial factor in averting the loss,
and (ii) the likelihood of injury would have been foreseeable to an ordinarily prudent person in a like position to
that of the defendant and under similar circumstances. It is not a defense to liability in such cases that damage to
the corporation would not have resulted but for the acts or omissions of other individuals.

The Del. Supreme court has since rejected the reasoning in Barnes v Andrews. Bank/Financial Institution
Directors can often be held to have a higher duty of care due to, (1) interested depositors in addition to
shareholders, (2) large amount of liquid assets create temptations, and (3) statutes can impose special
obligations which become a duty of care as a matter of corporate law.

Notes on Standards of Review and the Business Judgment Rule

Standard of conduct states how someone should conduct a given activity while standard of review states the test
the court should apply when reviewing someone's conduct. The ALI's principle of Corporate Governance states
that a director has a duty to perform their functions in good faith, in a manner that they believe to be in the best
interests of the corporation and with the care an ordinary prudent person would reasonably be expected to
exercise. The application of this standard of conduct to the functions of directors results in several distinct
duties; (1) duty to monitor, (2) duty of inquiry, (3) duty to make prudent or reasonable decisions on matters to
which they act upon, and (4) duty to employ a reasonable process to make decisions.

The standard of review applied to these duties is less stringent then the standard of conduct, standard of review
being the business judgment rule. The business judgment rule consists of four conditions, which if satisfied, is
applicable to claims based on the quality of a decision. The four conditions are: (1) Director must have made a
decision, (2) Director must have informed himself with respect to the business judgment to the extent he
reasonably believes appropriate under the circumstances, (3) Decision must have been made in good faith, and
(4) Director must not have a financial interest in the subject matter of the decision. The business judgment rule
will not apply when a board fails to reach an informed decision, in which case they will have the burden of
showing that the transaction is fair. If the four conditions are met, the decision will be reviewed not to determine
whether it was reasonable, but under a more limited standard such as if it was rational or in good faith. It is
much easier to satisfy a rationality standard then a reasonable standard.

If a director commits a tortuous act, he looses his corporate cloak and can be held civilly liable so is really
protected only for contract matters.

Directors and Officers Liability Insurance

Three elements may serve to reduce or eliminate civil liability for breach of duties; direct limits of liability,
insurance and indemnification.
49
Liability and legal expense of directors who are subject to claims based on a lack of duty of care and other
wrongful acts will often be covered by Directors' and Officers' insurance.

Class Notes

Duty of Care Doctrine

Why do you have both duty of care and duty of loyalty? Duty of care designed to promote profit maximizing
goals of company, duty of loyalty is basically incentives to keep managers from being thieves. Duty of care is
that a manager should act in the manner that a reasonable person in similar position would act. FL adds a good
faith requirement. Courts will use business judgment rule when confronted by dissident shareholders.

Note on pg 544 is good summary of what duties are.

Most duty of care cases are non-feseance cases, i.e. directors are not giving an adequate effort of attention. If
you're not making business judgments but just accommodating you are not protected by the business judgment
rule. Business hindsight bias is a worry, or people making judgments on your performance based on hindsight.
Additional problem in strong enforcement is that all the benefits of a good decision accrue to the corp. while all
the bad decisions will be accountable for by the director personally.

Ex.: Suppose one director talks others into buying his house at an inflated price? The one director violated his
duty of loyalty, while others are in violation of duty of care.

Joy v North
Builder is getting deeper and deeper in debt, no win situation. Good loan after bad then business finally fails.
Rational is do not want bank directors to be taking unnecessary risk with depositors money, risks that may be
acceptable in other industries.

No-win situation's can be different from a "bet the farm" situation. Illegal behavior would be a violation of the
duty of care, even if intention was to assist the business. If clearly illegal against social policy and duty of care.

Parnes v Bally Entertainment

Seems to be a slight back-track from Van Gorkom. As long as there is a process duty of care is met. As long as
there is a reasonable process with reasonable care should be ok.

Sarbanes-Oxley pg. 1964: Does the existence of Sarbanes application effect the application of State law? Most
important now is audit committee, must be financially independent. Must put in procedures, standards and rules
in place. Must put in whistle-blower protections and rules about disclosure by in-house counsel when they
discover financial irregularities. Appropriate funding must be given to audit committee, gives audit committee
power and then establishes rules to disallow manipulation. Essentially by-passes Directors and puts certification
duties directly on the officers themselves. Requires CEO to certify that to the best of his knowledge numbers are
accurate and he has done investigation within 90 days. Issue is now need to comply with Sarbanes, regardless of
state law corp. reporting requirements. Likely that Sarbanes will now start creeping into state law.

Precursor seems to be Caremark, dictum by Allen but then picked up by Del. Supreme Ct. overriding previous
law in Graham. Now Sarbanes seems to override Caremark doctrine.

Does business judgment rule eliminate the sting of the duty of care?

Freancis v. United Jersey Bank

FACTS: Plaintiffs are trustees is the bankruptcy of Pritchard & Baird Intermediaries. Defendant, daughter of
50
Lillian Pritchard, is executrix of her estate. Trial court characterized payments by the Pritchard’s as fraudulent
conveyances ad entered judgment of $10.3M against estate.
ISSUE: Whether a corporate director is personally liable in negligence for the failure to prevent the
misappropriation of trust funds by other directors who were also officers and shareholders of the corporation.
RULE: Courts find director liable i negligence for the losses caused by the wrongdoing of corporate officers.
NOTES: Unusual case as has duty to creditors as executrix, and duty to shareholders as director. Should have
resigned if unable to perform duties. Court says she has affirmative duty to bring the matter to the authorities if
she is unable to resolve the situation. Can read Freancis as either a duty to report to the authorities or duty to
investigate and report if something is amiss.

Kamin v. American Express Co.

FACTS: Complaint is brought derivatively by two shareholders asking for a declaration that a certain dividend
is a waste of corporate assets. AMEX purchased $30M of DLJ stock as an investment which dropped to $4M,
then sought to distribute the shares out to stockholders as a special dividend.
ISSUE: Whether actions of the directors of AMEX to pay dividend rather then sell shares was a violation of
duty of good care.
RULE: Business judgment rule requires that more then just the showing of another course of action is
necessary for an actionable claim, but also fraud, arbitrary action or a breach of trust.
NOTES: Lists 5 exceptions to business judgment rule. American Express bought DLJ stock which tanked, then
forgo an $8M tax credit in order to hide the bad investment. Holding is that business judgment rule protects the
dumb. No evidence of illegality or that four directors whose compensation was keyed to earnings induced
undue influence on the other 16 directors to vote their way. Considered by many a bad decision.

Smith v. Van Gorkom

FACTS: Class action brought by shareholders of Trans Union seeking rescission of a cash out merger with
defendant New T Co., a subsidiary of Marmon Group whose owner is Jay Pritzker. CEO of Trans Union, Van
Gorkom, explored a leveraged buyout after a "first and rough cut" analysis from the CFO Romans using $50-60
per share as a baseline for seeing if a buyout was feasible and to determine necessary cash flows. Van Gorkom
had been an officer for 24 years and was approaching mandatory retirement. Van Gorkom met with his friend,
Jay Pritzker, and offered a buyout package at $55 per share without the boards knowledge.
ISSUE: Whether the directors reached an informed business judgment in agreeing to sell the company as it
regards to two questions: (1) whether the directors an informed business judgment at the Sept. 20, 198 meeting,
and (2) if not, whether their actions subsequent to the meeting were adequate to cure any infirmity in their
action.
RULE: Directors did not reach an informed business judgment in voting to sell the company because; (1) they
did not adequately inform themselves as to the CEO's role in forcing the sale and establishing the share
purchase price, (2) were uninformed as to the intrinsic value of the company, and (3) were grossly negligent in
approving the sale of the company upon two hours notice without exigency of crisis or emergency. The court
never reaches the second question as directors post Sept. 20 meeting actions did not cure the problems.
NOTES: In response to case Del. legislature includes opt in provision so that a corporation can include in their
articles of provisions that corp. directors will not be held liable for business decisions, without opt. in Van
Gorkom still good law. Some states have opt out provisions. Van Gorkom autocratic CEO nearing retirement
and with a large shareholding. Company is a sitting duck for a takeover. Van Gorkom approaches Pritzker to
buy his shareholdings at $55 a share, Van Gorkom puts the number out there. Deal allows in event Van Gorkom
sells shares to anyone else at above $55, Pritzker can buy a huge minority share at $38, and company can not go
out and solicit other offers. Board does not get to see merger documents, take Van Gorkom at their word. One
view is that it is a self-dealing case as Van Gorkom ran the whole deal and did not fully inform others. In Del.
what constitutes duty of care and gross negligence is that board is not supposed to make rash and uninformed
decisions. Blind reliance considered here as all directors relied on Van Gorkom, but hard concept to nail down.
Issue is also magnitude of the deal, this one is a complete cash buy out. Questions raised about what kind of
reports are required and questions should be asked? Supposedly this case only requires good faith and
51
informed process, dissent says if the deal is good enough they should be able to go through with it and
give directors benefit of business judgment, majority retorts that you should at least engage in some
process to evaluate not just blind trust.

In re Caremark International Inc. Derivative Litigation

FACTS: Suit charging breach of fiduciary duty of care by Caremark directors as applicable to healthcare
providers. Caremark was charged with multiple Federal violations after a four year investigation. Caremark
agreed ton a plea involving one count of felony mail fraud and reimbursements of $250M to public and private
parties. Suit seeks recovery of those losses from the board of directors as individuals.
ISSUE: Whether Caremark's directors breached their duty of care by failing adequately to supervise the
conduct of Caremark employees or institute corrective measures.
RULE: In order to show Caremark directors breached there duty of care by failing to adequately control
employees, plaintiffs would have to show either, (1) the directors knew or (2) should have known that violations
of law were occurring and (3) that the directors took no steps in a good faith effort to prevent or remedy the
situation, and (4) that such failure proximately resulted in the losses complained of. Regarding the "negligence"
claim, where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating
activities within the corporation only a sustained or systematic failure of the board to exercise oversight will
establish the lack of good faith that is a necessary condition to liability. Directors here made a good faith effort
to be informed and did not know the specifics of the activities that led to indictments so they cannot be faulted.
NOTES: One case that differs from reasonableness standards of Duty of Care. Response to Caremark was
establishment of compliance officers and departments. Court states liability may follow from board decisions
that result in loss when, the decision was ill advised or "negligent", or when it arises from unconsidered failure
of the board to act in circumstances in which due attention would have prevented the loss. A second class of
liability can arise due to failure to monitor.

B. Duty to Act Lawfully

Text Outline

Two types of statutes are relevant to the potential criminal liability of officers and directors; (1) statutes that
make corporate managers criminally liable for unlawful corporate acts if the managers themselves performed or
caused the performance of the act, and (2) a statute that makes managers criminally liable for unlawful acts of
employees over whom they have the power of control, even if that power is not exercised.

Miller v. American Telephone & Telegraph

FACTS: Stockholders brought a derivative suit against AT&T and all but one director for failure to collect an
outstanding debt of $1.5M owed by the Democratic National Committee for communications services. Alleged
was a breach of directors duty to exercise diligence in handling affairs of the corporation, affording a preference
to the DNC on collection procedures in violation of the Communications Act of 1934 and effectively making an
illegal campaign contribution.
ISSUE: Whether shareholders had a basis for action for breach of duty.
RULE: Court points to statutory laws that give shareholders rights to challenge illegal corporate donations thus
providing them standing to seek damages.
NOTES: Not clear that this truly was an illegal act. Court takes position that this type of behavior as a general
rule should be considered illegal. Supreme Ct. later rules that private action will not be considered for campaign
finance violations, leaving only state action for duty of care.

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VIII. Duty of Loyalty

A. Self-Interested Transactions
Text Outline

In the past a director with a self-dealing transaction was often required to get approval from a disinterested
majority of the board. By the 1960's the law had evolved to where the suit of a shareholder, whether there was a
disinterested majority of the board or not, would be reviewed by the courts subject to rigid and careful scrutiny,
and invalidate it if found to be unfair.

Traditional remedies for violation of duty of loyalty are restitutionary in nature, normally rescission. A director
or officer who violates the duty of fair dealing may be required to repay the corporation any salary he earned
during the relevant period in addition to making restitution for his wrongful gain. Courts have sometimes
awarded punitive damages against directors or officers who have breached their duty of loyalty. The ALI also
states that directors or officers who violate their duty of fair dealing should be required to pay attorneys fees and
costs required to establish the violation.
Class Notes

Two types of hard cases, self-dealing transactions by a director and corporate opportunities that are taken by a
director, i.e. Meinhard v Salmon. Del. § 144 is a major source of law here.

Marsh pg 599: Shift as previously there was a prohibition on self dealing transactions. Sometimes, especially
with close corporations, self dealing transactions may be a better deal. Example is when a director provides a
loan to a corporation, and that loan may not have been available otherwise or at a worse rate. Explains how
many cases were decided in 80's & 90's as judges were looking at the economics of the transaction.

The tougher cases are the indirect self dealing transactions such as purchase from a company in which a director
has minor stake holding, family transactions, or conflicting board memberships.

Standard of liability in Del. is gross negligence. Levi theory that Fed. law is shaping state law. Federal
sentencing guidelines have been established in part to response to corporate wrongdoing, compliance
departments can allow you to avoid gross negligence charge and mitigate sentences handed out by Feds. §
102(b)(7) Del. response to Smith v Van Gorkom, can get exculpatory clause which protects directors, friendly to
corporations but an opt in provision. § 102(b)(7) does not exculpate itself, corporate charter does, statute just
allows a corporation to include in charter if voted on.

Derivative action is an action where shareholder sues on behalf of the corporation against the Directors,
effectively standing in the shoes of the corporation. Must demand action of the board prior to ensuing litigation,
but can argue that Directors will not act so demand should be excused. WD II is a case if demand should be
excused or not, Chandler does not dismiss the suit.

How is Sarbanes-Oxley affecting? Maybe affecting Del. law to make it more shareholder friendly. Pressure of
Fed Law on state law also manifests when board members have a special expertise, will those members with
special expertise be held to a higher duty? Del Ct. recently came down with a case in which the Directors did
not give information about an investment banking evaluation, lying director's get nailed but so did a
sophisticated business man on the board as his expertise should have allowed him to know the offer was to low
and unreasonable. Unsure how broadly or narrowly to read at this point.

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Has been very difficult for medium sized company's to comply with SOX, especially § 404 internal controls.

Lewis v. S.L. & E., Inc.

FACTS: Case arises out of an intra-family dispute over management of two closely held corporations. Donald,
one of the interlocking brothers, charged that his brothers had wasted the assets of SLE by causing SLE to lease
business premises to LGT from 1966 to 1972 at an unreasonably low rental. LGT intervened and filed a
complaint seeking specific performance of an agreement for Donald to sell his SLE stock to LGT. Donald
argued on appeal that the court improperly assigned the burden to him to prove waste, and as defense failed to
prove the transactions in question were fair and reasonable he was entitled to judgment.
ISSUE: Whether the trial court erred in assigning the burden to Donald given a self dealing transaction, and
whether the transaction was fair.
RULE: Burden should have been assigned to defendant directors as they were officers and directors of both
corporations, so it is their burden to prove the transactions were fair and reasonable. Business judgment rule
does not protect them due to their conflict of interest, and transaction is voidable if not shown to be fair and
reasonable to the corporation.
NOTES: Court seems to say that a self dealing transaction is ok as long as it is fair. Not fair here because
contemporaneous market test is not shown here.

In re Walt Disney Derivative Litigation , Del., 2003

FACTS: Suit to disgorge Ovits of his severance payment claiming directors breached their fiduciary duties.
ISSUE: Whether defendant directors of Disney should be held personally liable for a knowing or intentional
lack of due care in the decision-making process of Ovitz hiring and termination.
RULE: Acts of intentional misconduct or of omissions not made in good faith will not be protected by the
exculpatory clause in Disney's by-laws. Directors lack of care in an important business decision will not be
protected by the business judgment rule.
NOTES: Eisner hires his friend Ovitz as CEO, who then Eisner claims is a compulsive liar and huge spender.
Eisner fires Ovitz within a year. Shareholders bring a derivative suite, chancellor Chandler throws out, Walt
Disney I. In WD II here, court treats Eisner as a Van Gorkom because he has complete control of the board and
only informed them after the fact. Issue is Disney has a § 102(b)(7) exculpatory clause in their charter. Court
addresses by reviving the duty of care, adopting a freer standard of good faith, avoiding calling a duty of care
covered by he statute/clause. Is Chancellor Chandler laying out a different duty of care standard then Van
Gorkom and going around § 102(b)(7)? Some say Chandler would be responding to pressures of Fed law. No
prohibition on self dealing transactions, none found in this case, but would be measured under reasonableness
standard. Breach of duty of good faith gets the gross negligence standard, but WD II now Chandler gives
alternative end around § 102(b)(7). In Van Gorkom issue was cash-out merger, WD II transaction is about hiring
and salary of board manager....broadening areas of ordinary business practices that will be viewed.

Talbot v. James
FACTS: Suit brought by the Talbot's against James, president of the Chicora Apartments, alleging that he
diverted specific funds to himself while an officer and director. James appeals after judgment against him for
$25K stating he was not entitled to overhead and profits resulting from a construction contract. After agreement
in which Talbot's contributed land and James labor and expertise to build apartments each for 50% share of
stock, he awarded construction contract to James Construction wholly owned by himself.
ISSUE: Whether it is a breach of duty of loyalty for James as president, officer, and stockholder of the
company to authorize a contract to a company owned by him from which he received profits and salary.
RULE: Directors are prevented from secretly using their fiduciary positions to their own advantage and to the
detriment of the corporation and stockholders. James was compensated for his construction supervisory duties
when he received his 50% share so he is not entitled to any other compensation.
NOTES: Talbot the incompetent wins and James who makes a total of $2,200 looses. To build apartments from
another company other then James' would have cost $25-35K, plus did not have to pay up front, then James
made project work. Court found that there was not disclosure that James was building due to failure to inspect
54
books, did not disclose that he was going to get up front fees. Bottom line is deal seemed to be substantively
fair, and there was adequate disclosure that he was going to be the general contractor, just that there was not
detailed disclosure. Question comes down to what is the necessary level of disclosure balanced against a fair
deal.

B. Statutory Approaches
Text Outline

A review of the substantive fairness of a self-interested transaction may be thought of as a surrogate for a
review of the fairness of the process by which the transaction was approved. Many of the recent statutes on this
subject are susceptible to the interpretation that approval by disinterested directors precludes a judicial inquiry
into fairness, but almost all can also be interpreted not to preclude such an inquiry. Statutes such as that in NJ
have made it clear that a transaction is not voidable solely because of a director conflict if any one of the
following conditions are met: (1) the transaction was fair at the time it was authorized, (2) disclosure was made
to directors of the conflict and disinterested directors approved, or (3) disclosure was made to the shareholders
and the shareholders approved.

In Cooke v. Oolie defendant directors who had made a loan to the company claimed that only the business
judgment rule should apply as the transaction was approved by disinterested directors, the court rejected this
argument. Court states that where there has been authorization by disinterested directors, the complainant must
show that disinterested directors "could not have reasonably believed" the transaction to be fair to the
corporation. This test is intended to be easier for the director or senior executive to satisfy then a full-fairness
test, though harder to satisfy then the business-judgment standard.
Class Notes

Del Corp Statute § 144: Interested Directors

§ 144(a)(1): Disclose must be of material facts to the contract or transaction, and to any conflict of
interest. Good faith majority director approval, or
§ 144(a)(2): Disclosure and Good Faith majority shareholder approval, or?
§ 144(a)(3): Fairness

Disinterested Directors are those that do not stand to have financial interest. Disinterested directors goes back to
issue on one overriding board member being an overriding influence i.e. Van Gorkam. Question is fairness
alone a factor that can be decided on by the courts or a factor that must be in addition to (1) and (2) allowing for
court second guessing? Courts focus on different branches of the above, some fairness, some disclosure.
Looking at nature and adequacy of disclosure is same as looking at disclosure.

Page 84 Supp. Cook v Oolie, looks at business judgment rule and fairness. Chandler saying folks to worry about
are the controlling shareholders. Court is not going to just override the vote, but fair process must occur and
vote needs to be fair. Chandler says need fully informed vote, will be fairness review, and will consider business
judgment as opposed to Huizenga that looks at process only.

§ 144(a)(1) requires looking at this particular transaction at this particular time to make sure it is a good deal. A
self dealing transaction can still get by, under exacting scrutiny, if it is a good deal for the corporation.

Oracle is closer to the duty of care obligation then Beam case, problem of friends on the board who are
expected to vote with the CEO. Though Oracle is Chancellery Ct and Beam v Stewart is Supreme Ct. i.e.
Economic interests, interested party, Interlocking Directory, interested party, Friend & Golf Buddy on board,
alone not enough to be an interested party but a factor that can be weighed if other factors are present,
especially under SOX.
55
SOX comes right out and says that if a company has to come out and restate earnings, the CEO needs to kick
back the compensation they received during that time.

Fliegler v Lawrence: Can read Fliegler more narrowly then what is stated, same with Nakash. Eisenberg does
not like self dealing transactions and feels shareholders do not know if a deal is fair or not. Eisenberg wants to
say that courts need to get in and perform fairness review as a backstop to § 144. Courts have been reviewing
the fairness of self dealing transactions to varying degrees. Oolie first said will need to look at fairness of
transaction, judge changes mind in later case that if not majority shareholder burden is on plaintiff to show
unfairness of process, otherwise business judgment rule. Takes a hard look to see if § 141(a)(1) applies, but does
not completely give up looking at fairness of the deal.

If Self Dealing transaction, burden on D to show fairness, if statute applies:

If: a) § 144(a)(1)-----Business Judgment Rule (?), Cooke, Emerald, Kahn
or If: b) § 144(a)(2)----Interested (controlling) shareholder, burden shift to plaintiff to show unfairness.

Other jurisdiction approaches: CA statute if shareholder vote no just and reasonableness review, if director vote
there will be one. Model act provides very bright line rules. FL § 607(6).482 approval by shareholders needs to
be by majority of disinterested shareholders.

Cookies Food Products v. Lake Warehouse

FACTS: Plaintiff alleges that Herrig, by acquiring control of Cookies and executing self-dealing contracts
breached his fiduciary duty to the company and fraudulently misappropriated corporate funds. Herrig agreed to
an exclusive distributorship agreement for the barbecue sauce through an existing network of auto-parts stores
of which he was sole owner. Herrig later purchased adequate stock to become the majority shareholder and
replaced four of five board members.
ISSUE: Whether self-dealing transactions by Herrig were a breach duty of fair dealing.
RULE: Though self-dealing transactions were numerous, the fact that adequate knowledge of information was
provided to the board, that compensation for those contracts was fair, and that these contracts were a contributor
to the success of the organization precludes finding a breach of fair dealing.
NOTES: Cookies BBQ sauce not making any money until Speed Herrig came into the business picture. He is
majority shareholder, president and getting a consulting fee. Court says to look at the great job he did for the
company, even after saying profitability is not the litmus test. Court says there was no need to disclose profits.
Misreading of Talbot? Court is interpreting statute as saying that board has some level of inquiry and scrutiny. If
disclosure is supposed to be so fact specific how can you say no one was harmed? Argument against Speed is
that he set up deal so that he earned cash, while all other shareholders were holding shares they could not sell.
Key point is subtlety of differences in self dealing reviews by different court jurisdictions. Options for review
are smell test, business judgment rule etc., courts pick different rules as in SC Talbot court picking disclosure as
the key issue, Lewis looks at self dealing deal. Cookies knows of self dealing and disclosure, but chooses not to
look at those factors in as high a level of detail.

Emerald Partners v Berlin , Sup. Ct. Del., 2001

FACTS: Emerald Partners LP filed action to enjoin consummation of a merger between May petroleum and
thirteen corporations owned by Craig Hall, CEO. May's directors were also enjoined.
RULE: Though no longer controlling shareholder, Hall's stance on both sides as a corporate fiduciary alone is
sufficient to require the demonstration of entire fairness. § 102(b)(7) does not permit shareholders to exculpate
directors for violation of loyalty or good faith. Director defendant can avoid personal liability only if they have
established that their failure to withstand an entire fairness analysis is exclusively attributable to a violation of
the duty of care.

56
 C. Compensation, the Waste Doctrine, and the Effect of Shareholder Ratification
Class Notes

Numbers with stock options are huge. Directors vote on their own compensation so scurrilous area, but
compensation is necessary. Supposed to be dealt with in public corporations as not self dealing so given great
deference by courts, also looked at more closely in close corporations due to opportunity for manipulation. SEC
disclosures of salaries are required, give shareholders ammo in lawsuit, SOX requires kickback of
compensation, IRS baseline of $1M for CEO salaries.

Harbor Finance v Huizenga , Del Chancery, 1999

FACTS: A Republic Industries shareholder brings suit on the grounds that acquisition of AutoNation was
unfair. As acquisition was ratified in a proxy, challenge could only be made under the doctrine of "waste."
RULE: Court rules that the doctrine is an unnecessary vestige and more then adequately covered by the
business judgment rule and other doctrines. Waste is dead in Del.

D. The Corporate Opportunity Doctrine

Text Outline

The main test applied to the Corporate Opportunity Doctrine is the "line of business" test first applied in Guth v
Loft. Another is the Durfee "fairness" test. Miller v. Miller holds a combination of these two tests. The ALI
states the general rule directors/executives may not take advantage of a corporate opportunity unless (1)
directors/officers first make the offer to the corporation and disclose the conflict, (2) the opportunity is rejected,
(3) either (a) the rejection is fair (b) the opportunity is rejected in advance by disinterested directors, (c) the
rejection is authorized in advance or ratified.

The Corporate Opportunity Doctrine now as outlined by the Del. Guth v. Loft progeny is that a director may not
take a business opportunity as his own if: (1) the corporation is financially able to exploit the opportunity, (2)
the opportunity is within the corporations line of business, (3) the corporation has an interest or expectancy in
the opportunity, and (4) by taking the opportunity the corporate fiduciary will thereby be placed in a position
hostile to his duties to the corporation. As a corollary, he may take the opportunity if: (1) the opportunity is
presented to the director in his individual and not his corporate capacity, (2) the opportunity is not essential to
the corporation, (3) the corporation holds no interest or expectancy in the opportunity, and (4) the director has
not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity.

E-Bay: Shareholders file derivative suit for usurping corporate opportunities. Directors of E-Bay were charged
with accepting "flipping" stock from Goldman, an opportunity that should have gone to the company. E-bay
insiders are held to be potentially liable as this "gratuity" should have rightfully gone to the company and was
intended to bring business Goldman's way and thus is a likely breach of fiduciary duty.
Class Notes

Three categories of corporate opportunity. Brudney and Clark proposal is attempting to map out a safe zone, but
has not been going far.

Lines of tests for corporate opportunity standards:

(1) Interest/expectancy: Starts in Alabama case. Adopts view if corporation already has an interest,
answer no, so ok for insider to take an interest. Would not fly today and even Alabama has narrowed.
Very property ownership view.

57
 (2) Line of business: Guth v Loft Pepsi case discussed in NE Harbor is key Del. case on line of business,
easy case as corporate assets were used in secrecy requiring handing over all shares of new corporation.
Test is does the opportunity present an especially favorable business opportunity for the company given
necessary assets and talents. Test up until Broz.

(3) Fairness: Ballentine analysis, special or unique value, opportunity presented to board, same line of
business. Ballentine takes all other tests and lumps them together as one. Often contradictory lines of
argument. When would it be fair to make a judgment that it is a corporate opportunity or not. Basically
saying look at the overall fairness to the corporation.

(4) Mixed Miller: Courts focus on is the taking of the opportunity harming the corporation. Intermediate
step to Broz.

(5) Broz: Del. view, is opportunity interest in an area of business where corporation would be expected
to participate, i.e. same line of business test as Meinhardt v Salmon. Problem with what specificity of the
business areas should be, especially with conglomerate type business'. No one factor is dispositive, all
factors must be taken into account given to context. Interest and expectancy broadly defined as well as
how opportunity came to insider and nature of opportunity. Broz important case due to interlocking
directorships. Delaware Court does not adopt disclosure requirement, but states that disclosure would
create a safe harbor. Interest band expectancy broadly interpreted, 4 factors in Broz test. Currently law in
Del. Can business afford and adapt to the corporations point of view. Court views financial ability to
take on opportunity as a defense putting burden on insider to prove if they go after the opportunity.

(6) ALI/N.E. Harbor: Adopt a test of full disclosure and rejection. Will never be fair for insider to take
opportunity that could have been corporations, but can make argument for an opportunity that was
rejected.

Difference between ALI/NE test and other is the disclosure factor. No other tests require disclosure as a pre-
condition. ALI disclosure standard pg 679. Business judgment rule if opportunity was rejected by directors.
Also includes a "how did the opportunity get to the director" test.

E-bay has a very broadly interpreted line of business. E-bay had a particularly unusual situation as the four
directors had 40% control of the corporation and were paid only in stock options.

Traditional three factors in corporate opportunity defenses: Financial incapacity (Pablo case), legal incapacity,
and refusal to deal (third party will not deal with Corp.). Financial incapacity of corporation is often the key
defense accepted by courts. Corporate opportunity is subset of duty of loyalty, and need to look carefully if
assets are being utilized.

What are your obligations when you own the company vs. what are your obligations when you sell your stock.

Hawaiian International Finance v Pablo , HW, Sup. Ct., 1971

FACTS: Pastor Pablo and Rufina Pablo were directors in Pablo Realty. They went to CA at their own expense
and on return advised appellant about attractive real estate deals there. Pablo entered into an agreement to
purchase two parcels of land on behalf of the appellant, in which he had an agreement for a kickback of 1/2 the
commission from the selling agent. Pablo explained that as a real estate agent he was entitled to commission
after close.
ISSUE: Whether a corporate officer acting for the corporation in the purchase of investment real estate can
retain a commission received from the real estate brokers representing the seller, absent disclosure and an
agreement with the corporation.
RULE: Had Pablo disclosed the fact that he had been anticipated commissions the case would be different as
58
appellant would have had an opportunity to either attempt to obtain the property at a price less the commission
or it could have agreed with Pablo to acquiesce in letting him retain the commission. Pablo is liable to appellant
for the commissions he received.
NOTES: Unclear use of corporate asset for benefit, he could possibly have used asset after if venture
unsuccessful, court focuses' on secrecy.

Northeast Harbor Golf Club, Inc. v. Harris

FACTS: Club maintains that Nancy Harris breached her fiduciary duty as president of the club by purchasing
and developing property abutting the golf course.
ISSUE: Whether real estate transactions that were not in the interest of the club were a breach of fiduciary duty.
RULE: In the past the view was that directors cannot serve both themselves and the corporation at the same
time. Now the court feels that it is important to preserve some ability for corporate fiduciaries to pursue
personal business interests that present no real threat to their duty of loyalty. Disclosure is a key element though,
and here Harris did not disclose the opportunity to the court so the prior judgment in her favor is reversed.
NOTES: Maine court chooses to use different doctrine then normal corporate opportunity doctrine. Courts now
feel that is some circumstances, especially closed corporation context, strict rules are no longer applicable.
Outside directors are basically charged with checking the power of the inside directors.

59